What is a chart of accounts & is it important?

Keeping track of all the money moving in and out of your business can be a challenge, but it’s important for anyone who wants an insight into their cash flow, as well as an overview of the general financial health of their company. That’s why a chart of accounts can be a beneficial addition to your financial analytics tools. Explore the definition of a chart of accounts and find out why a chart of accounts is important with our comprehensive guide.

Chart of accounts explained

First off, what is a chart of accounts? In short, it’s an index of all the financial accounts in your company’s general ledger. It allows you to break down all the transactions that your business made during a specific period into different subcategories. By separating out your revenue, liabilities, assets, and business expenditures, a chart of accounts enables you to gain insight into the effectiveness of different areas of your business.

How does a chart of accounts work?

In a chart of accounts, accounts are shown in the order that they appear on your financial statements. Consequently, assets, liabilities, and shareholders’ equity (balance sheet accounts) are shown first, followed by revenue and expenses (income statement accounts).

Within your chart of accounts, these broad categories are likely to have a significant number of subcategories. For example, assets can include the following sub-accounts:

• Accounts receivable

• Cash

• Prepaid expenses

• Inventory

• Fixed assets

• Petty cash

• Marketable securities

• Allowance for doubtful accounts

• Accumulated depreciation

Liabilities may also be broken down into these sub-accounts:

• Accounts payable

• Wages payable

• Notes payable

• Taxes payable

• Accrued Liabilities

While shareholders’ equity may consist of the following sub-accounts

• Preferred stock

• Retained earnings

• Common stock

Furthermore, you may decide to structure your chart of accounts so that revenue and expenses is categorised according to business function, product line, or company division.

Each account on the chart of accounts contains an identification code, description, and name. This makes it easier to locate specific accounts, as a chart of accounts can get complex, especially for very large companies. For an international corporation with multiple divisions, the chart of accounts may even include thousands of individual financial accounts.

Understanding why a chart of accounts is important

The chart of accounts is important for several reasons. Most importantly, it provides you with a clear picture of the financial health of your company. This is useful not just for business owners, but also investors and shareholders who may not have a handle on your company’s day-to-day operations. It also makes it easier for businesses to comply with financial reporting standards, which makes a chart of accounts extremely beneficial for businesses of all sizes.

Chart of accounts example

There are a broad range of chart of account examples available online, which can give you a better sense of what this important financial document should look like. We’ve also put together a partial chart of accounts example (remember, these documents can be extremely complex) for you to take a look at:

How to improve your chart of accounts

When you’re producing a chart of accounts in Australia, consistency is key. Try to make a chart of accounts that won’t change for several years so that you can more easily compare results. If you keep adding new accounts, then it will become increasingly difficult to compare your financial information over a multi-year period. You should also regularly review the chart of accounts to see if any accounts contain inessential data. If they do, shut down these accounts to keep the chart at a manageable size.

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