What is the “Chart of Accounts” and why is it important?


According to Wikipedia “It is used to organize the finances of the entity and to segregate expenditures, revenue, assets and liabilities in order to give interested parties a better understanding of the financial health of the entity. Normally defined by an identifier and a heading explaining text title and coded by account type.”

Why is this important? The chart of accounts quite simply organizes your finances so that reports make more sense. It creates an organized system to read the financials. Without it you would have all the same info but it would not be all over the place, and very difficult to decipher.

Some larger businesses will use a detailed version, while most small businesses can get away with a much smaller, more watered down version but they are all the same. Regardless of business size, industry, or entity type they all use a chart of accounts.

This is not specific to any industry, or entity type, it is the same for every business. When you are starting to set up your chart of accounts it will be organized the same as every other company. Bank accounts first, then all assets, liabilities, equity, income, and expenses in that order.

Your accounts receivables are considered an asset, and so is your income but they are two completely different things. Accounts Receivables are business claims against the property of a customer arising from the sale of goods and/or services. Income is what you have collected from the sale of products or services. Basically, if you bill a customer and give them time to pay it is accounts receivable, and when you collect the money, deposit it into your account then it is income.

Liabilities are notes owed by the business. So if you are leasing or buying anything on credit then it is a liability. An equity account would be any equipment the company has paid for. Or would receive money for if sold. If you had a loan on a vehicle the payment would be a liability while the vehicle itself would be equity. As you make a payment the amount of the liability goes down while the amount of the equity account would increase. So to keep your balance sheet accurate you would need to track both.

Expenses are just that, money paid out by the business for the operation, and production of goods and services paid for immediately. For example, things like charges to Staples for the purchase of office supplies, or if you went to the gas station for fuel for the fleet of vehicles, it is simply an expense. Where accounts payable would be expenses that you did not pay right away. So if you purchased materials for a landscaping job, but the person you bought them from gave you 15 days to pay the invoice that would be accounts payable.

When you are tracking your accounting whether you are using the old-fashioned paper and pencil, or you use accounting software you need to know where your money is coming from, and where it is going the chart of accounts is simply the organization system used to keep this information together.

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