Your chart of accounts is the backbone of your company's accounting processes. A well organized chart of accounts can enable management to make informed strategic decisions as your company grows. Likewise, a hastily thrown together chart of accounts can haunt your organization for years to come and create significant issues, even as your company succeeds in other areas.
By taking a little bit of time to form a deliberate approach to setting up your accounts early, you can save yourself a lot of heartache later. We've summarized 3 key tips to ensure your chart of accounts is in good shape from day one:
1) Create a numbering convention
Accounts are grouped into types (Assets, Liabilities, Revenue, Expense, or Equity) based on the nature of the account. These types create natural groupings within the chart of accounts. Assets typically start at the lower numbers (1xxxxx's and/or 2xxxxx's), followed by liabilities (2xxxxx's or 3xxxxx's), then revenue (4xxxxx's or 5xxxxx's), expenses (typically 6xxxxx's) and equity (7xxxxx's+). Depending on the number of digits in your account numbers, there's typically plenty of space within each of those types to break down the convention further.
Next you want to look at each of your key accounts and determine how they should be numbered. For these key accounts, it's best to choose numbers that are easily memorizable, don't have more than 4 repeated digits, and use these numbers as the beginning of category groupings.
For instance, Operating Cash may be 110000 and Accounts Receivable may be 110100. This makes it clear that anything numbered 110000-110099 should be categorized as Cash, while indicating that 110100-110199 is likely related to Accounts Receivable (e.g. Allowance for Doubtful Accounts, Unbilled Accounts Receivable).
2) Utilize other dimensions to minimize your chart of accounts
If you ever think about adding a department or location in an account's name, reconsider your decision. Accounts are meant to be financial accounting concepts that span your organization. If the same financial accounting concept applies to more than one area (e.g. Marketing vs. Accounting departments), you should use the same account with a different Cost Center (sometimes called Class or Department). Similarly, organizations with multiple business units should add dimensions to carve out accounting related to those distinct entities.
3) Establish controls
One of the great advantages of developing an organized chart of accounts and related dimensions, is that it enables you to control your financial transactions. For instance, Cost Centers and Locations can have their own permissions for which accounts are allowable. This provides a distinction for which types of employees are allowed to book expenses to which accounts, which departments are classified as cost of services vs. G&A, and more.
Further, building these controls directly into your chart of accounts enables your organization to control your financial transactions in a scalable way. By restricting certain Account/Cost Center combinations, for instance, ensures no transactions will ever be booked to those Accounts by employees in restricted Cost Centers.