The Chart of accounts (COA) is a list of the accounts used by an organization’s accounting process. The list can be numerical, alphabetic, or alpha-numeric.
The structure and headings of accounts should assist in consistent posting of transactions. Each nominal ledger account is unique to allow its ledger to be located. The list is typically arranged in the order of the customary appearance of accounts in the financial statements, profit and loss accounts followed by balance sheet accounts.
While ostensibly the COA is a categorizing approach, if set up with careful forethought, your COA “…can be one of your most useful tools in analyzing your business,” says Donna MacMillian of Bookkeepingrus.com in Portland, Maine.
By designing your chart of accounts with the financial analysis of your company in mind, you will be able to see just where your profits are coming from and where your expenses need to be examined. How so?
By setting up income accounts for each department or segment of your business you will get a view of which areas are working for you. And by breaking out your expenses, both direct and indirect, within these income areas, you will also see which areas are most profitable. For example, if you are in the business of general contracting, you might build custom homes, do remolding, rehab older buildings and incur warranty costs. Wouldn’t it help you if you knew how much income was coming in from each of the services you provide? And how much profit each of the areas was bringing into the company?
If you are lumping warranty costs into general expenses then how do you know how much it is costing you? In this example, you would want to set up an income account for each of the profit areas you would like to track – Custom Homes, Remolding, and Rehab. You would also set up sub accounts for each of the Cost of Goods Sold accounts tying each sub account into a profit area. If you had an account called Materials (or Labor, or Subcontractors) you would set up a sub account under Materials for Custom Homes, Remolding, Rehab, and Warranty Costs. While you don’t need an income account for Warranty you will want to track the expenses you incur. In fact you might want to set up a Warranty sub account for each profit area under each Cost of Goods Sold account, thereby allowing you to see where your warranty costs are adding up. For each account in your Cost of Goods Sold section repeat this process of setting up sub accounts for each business segment.
If you wished to get a more concise view of each of the segments of your business, then you could assign a percentage of General and Administrative Expenses to each of profit centers.
With these facts available you can make good decisions as to what areas it makes sense to extend growth, or perhaps to cease operations. And while I have used the construction industry as an example, this works in every type of industry. And your chart of accounts can be expanded or compressed as your business needs arise.