A company of any size can benefit from putting a certain amount of forethought into the set up and design of its Chart of Accounts (COA). This is essentially a company’s system of categorizing and classifying transactions in the general ledger. A best practices COA should use standard accounting principles, incorporate items that are specific to your business, and allow for flexibility as your business grows and changes. Perhaps most importantly, your COA should be set up for clearly defined outputs that will allow you to report your finances and business metrics to executive management, investors, lenders and regulatory agencies without the need for complicated, time-consuming manipulation of data.
Establish a Scalable Chart of Accounts Hierarchy
The COA should follow a logical hierarchy that has a numbering system which allows for scalability. At the highest level the account numbers should be defined by account type:
Balance Sheet Accounts
10000 Assets Accounts
20000 Liability Accounts
30000 Ownership/Stockholders Equity
Income Statement Accounts
40000 Revenue Accounts
50000 Cost of Revenue (COR) Accounts
60000 Operating Expense Accounts
This numbering system will allow for various levels of subgroups as needed. Subgroups and subaccounts are useful to provide a reasonable level of granularity, but should be meaningful and not contain more detail than is necessary for reporting needs. There are numerous examples of typical accounts found in charts of accounts, which vary by company size. For example, Revenue and Cost of Revenue (COR) subaccounts might map to different product lines or business segments within the company. This will be useful for tracking the profitability of each revenue source, and for the comparison of each revenue source versus the forecasted expectations for that revenue source.
41000 SaaS License Revenue
42000 Customer Service Revenue
43000 Maintenance Revenue
51000 SaaS License COR
52000 Customer Service COR
53000 Maintenance COR
In setting up an expense account hierarchy, it is best to follow the breakdown of the most commonly used ‘element’ groups to get a clearer picture of where your costs lie. A logical, standard set of parent expense accounts would look as follows:
60000 Operating Expenses
61000 Compensation Expenses
62000 Non Compensation Expenses
62100 General Admin
62300 Travel and Entertainment
62400 Professional Fees
62700 Product Expenses
And the lowest level subaccounts can be easily inserted within these groups:
62300 Travel and Entertainment
62330 Travel Other
Things to Remember When Naming Subaccounts
As you create the account and subaccount names, it is important not to repeat names (e.g., do not have an ‘Other’ account in the Marketing group and an ‘Other’ account in the Technology group – it is better to have one called ‘Marketing Other’ and one called ‘Technology Other’).
Also, account numbers that begin with a zero or account names or numbers that use non-alphanumeric characters should be avoided. These conventions will make for better and easier reporting functionality when exporting data out of your GL software.
Further Organize with Classes
Lastly, one more level of dimension that is provided for in most GL software packages are classes. Classes can be used to separate data among business departments rather than duplicating major income or expense account sets, and will allow for a matrix view of your data. The class is a way to tag each revenue or expense item using a set of labels that you create. For example, assume you have three departments (Development, Sales, and Operations) within your organization and each department head is responsible for his or her own budget. By tagging each expense to a department code or ‘class’ you can create the granularity needed for each department to view its expenses versus its budget. So the matrix report related to airfare might look like this:
All of these guidelines are helpful, but what is most important is that you know your business best. The more thought you put in to what you want to get out of your COA data, the better job you will do getting it set up in the first place and the more time and energy you will save in the long run.