Understanding Your Chart of Accounts
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Understanding Your Chart of Accounts

Businesses and companies participate in many kinds of transactions. These might include acquiring a new loan or purchasing office supplies. But with each transaction, you must record it in the correct business account. So how do you know where you should record it? Your chart of accounts will show you where to enter your financial transactions.

What is a Chart of Accounts?

Your chart of accounts is a list of a company’s accounts all in one place. It helps you organize information for your financial statements. Also, it provides a clear picture of your organization’s financial health. In other words, it’s a big picture view of each section of your company that either spends or receives money.

What Should You Includein Your Chart of Accounts?

Your chart lists all of the accounts involved in your day-to-day business operations. You will list the accounts in the order in which they appear on your financial statements. They are organized into five main categories or accounts: assets, liabilities, equity, revenue, and expenses.

Assets

Assets are resources that have a monetary value. The company can also convert them into cash. Examples of assets include cash, accounts receivable, inventory, and fixed assets.

Liabilities

Liabilities are your business’s debts that you owe to someone else. Examples include accounts payable, accrued liabilities, taxes payable, and wages payable.

Equity

Equity is the ownership of a company. Also, your chart can include your shareholders’ equity.  Shareholders’ equity reflects your organization’s value once its investors and stockholders are paid. Examples of equity include common stock, preferred stock, and retained earnings.

Note – the role of equity is different in the chart of accounts depending on whether you’re a sole proprietorship, LLC, or corporation.

Revenue

Your revenue is the quantity of money your company brings from selling products or services to customers. Examples of adjustments included in the chart of accounts for revenue include sales returns and allowances.

Expenses

Expenses are the costs you incur as a result of running your business. Examples include the cost of goods sold, rent expenses, payroll tax expenses, and wages expenses.

Corresponding with Your Balance Sheet and Income Statement

Your balance sheet and income statement are two of your financial statements. You’ll notice they correspond to the different categories within your chart of accounts.

The Balance Sheet

Your balance sheet is a type of financial statement.  It shows asset accounts, liability accounts, and equity accounts at a specific moment in time. It’s a snapshot of what a business owns, owes, and what investments shareholders make.

The Income Statement

The income statement focuses on a company’s revenues and expenses during a specific period.

Note – the balance sheet and income statement account’s interactions are complex. Generally speaking, revenues increase your business’s equity and asset accounts. At the same time, expenses decrease your assets and equity.

Reference Numbers

A five-digit reference number precedes each account listed in your chart of accounts. The first digit correlates with one of the five major categories listed above. For example, 1 for asset accounts, 2 for liability accounts, etc.

Why is a Chart of Accounts Important?

It acts as a map or guide for your company and its financials. When it’s well organized, your chart of accounts should divide the most important business categories. And this makes it simple to decide which transactions you should record in the correct account.

Other benefits of having an organized chart of accounts include:

  • Helping you make better business decisions
  • Providing an accurate picture of your organization’s financial health
  • Making following financial reporting standards easier
  • Helping you understand your earnings
  • Better understanding your debts
  • Giving you a clear picture of your spending habits
  • Helping you answer the crucial question, “Where can I cut costs?”

Your chart of accounts is an organized, comprehensive list of essential business categories or accounts. It plays a vital role in the overall financial health of your company. Utilizing your chart of accounts will only make your business run more effectively and efficiently.  If you’re looking for support with your chart of accounts process, call us today! At Belfield Management Solutions, we aim to help take your business to the next level of success!