Understanding Your Chart of Accounts

Learning to understand your business accounts goes a long way to identifying financial challenges. It gives you the ability to address them early so they don’t blossom into a colossal crisis.
No matter what software you use, bookkeeping is the process of recording and organizing financial data for your business. The primary reason is to see the profitability of the business. Some of you may not be passionate about bookkeeping. Let’s face it. It’s usually the last thing a business owner wants to do. But given the right tools, you may not find it so overwhelming. Once you have an effective bookkeeping system, you will feel more confident in your business and better able to plan for the future.

Let’s start with the chart of accounts. There are four main sections to the chart of accounts, and they are:

*Assets – Bank, cash, inventory, accounts receivable, and resources owned by the business.
*Liabilities – Debts and payments owed from the business to another business or entity like loans and accounts payable.
*Income or Revenue– Cash flow into the business earned by sales.
*Expenses – expenses that the business needs to pay in order to do business like office supplies and payroll.
*Equity – The owner’s held interest in the business. Assets are subtracted from liabilities to give you the value of your business. The above sentence is the accounting equation. Dividends and retained earnings fall under this moniker.

No two businesses use the exact same chart of accounts, but most of the accounts are common. Therefore, these accounts and their subaccounts make up the chart of accounts in bookkeeping.

Now that you have the basics of the account sections let’s dive a little deeper.

All the above account sections are divided into the income statement and the balance sheet. Balance sheet accounts are assets, liabilities, and equity. While income and expenses belong on the income statement, sometimes called the profit & loss statement.

Balance Sheet

Assets
Assets can be cash, accounts receivable, and inventory. Fixed assets like buildings, equipment, and land are also included. If you look at the balance sheet, you will see that the accounts start with the bank and cash accounts, then inventory and receivables, and below that are the fixed assets. Typically these accounts are organized by their liquidity, with, of course, cash being at the top.

How Liabilities and Expenses Differ
Liabilities are expenditures used to purchase physical assets for your business with a lasting value. For instance, buildings, land, equipment, and vehicles. On the other hand, expenses are purchases for services or items with no physical value to the business, like stationary and utilities. In other words, expenses are for items and services that the company will use up.

Short-Term and Long Term Liabilities
Short-term liabilities refer to debts for asset purchases that will be paid off within a 12 month period. Some examples are wages, credit card debt, interest payable, GST, and taxes payable.
Long-term liabilities are debts that last past a year. These may include mortgages and large equipment purchases or leases.

Equity
The equity section of the chart of account sits at the bottom of the balance sheet and represents the remaining value of the owner’s interest in the company. Thus, the accounting equation is “assets minus liabilities equals equity.”
Owner contributions or retained profits can create equity for the company.
When an owner takes a draw from the company-it will decrease the equity. Some examples of equity accounts are dividends, retained earnings, and company shares.

Income Statement (Profit & Loss)

The income statement is a bit more intuitive for new business owners, and the information that is more relied upon. It represents the final net profit at a given period in time.

Income
Income accounts are classes of revenue that show how much the business has earned. When you generate an invoice for your customer, it increases your revenue. When you issue a refund, it will decrease your income.

Expenses vs. Cost of Goods Sold
Regular expenses are the costs of doing business—for example, rent, utilities, and office supplies. Expenses are the last section of the income statement and are usually the most extensive section on it.
On the other hand, the cost of goods sold are the expenses directly tied to the production of what the company is selling. These costs would include product cost, subcontractors, and freight. Simply put, when a take-out restaurant sells a meal, the COGS would consist of the meal and the take-out container. When trying to decide on the type of expense, ask yourself: “Would I have this expense if I didn’t have a sale?” If the answer is “no,” then it is an expense. The COGS section sits in the middle of the income statement below income and before the expenses.

So now you have a basic idea of your chart of accounts. It is essential for a business owners to know where they stand financially. Your business should grow without you feeling overwhelmed by creating good bookkeeping habits for tracking your income and expenses.

KineticBooks & Tax Solutions can keep you on track with all your business bookkeeping questions and systems. We can set you up with an easy-to-use structure and help you along the way. Call us at 604.245.0418 or email us at info@kineticbooks.ca