Unless you are well-versed in the accounting and financial world, the concept of a “chart of accounts,” may be new to you. It really is not that difficult. Essentially, a chart of accounts is a list of categories for your various business accounts: cash and equity, assets and liabilities, income and expenses. Keeping the chart accurate helps you know at glance the value of the business and whether it is growing or losing money.
Many business owners make critical decisions based simply on the balance in their bank account on a particular day. A chart of accounts gives a more accurate picture of where the business stands and enables accurate predictions of where it is headed. Using the chart of accounts makes it easy to generate reports to understand the health of the business. You are able to anticipate tax payments, track depreciation, plan for selling assets that are no longer needed.
Often, businesses do little more than track their sales (income) and their bills (expenses). For most businesses this is inadequate. Each company is different and depending on how it is structured, you won’t see an accurate picture of the company’s health with just an income and expense report.
Chart of Accounts and Car Expenses
For instance, if your company owns a fleet of cars, you can't deduct the price of the cars all at once. You can, however, depreciate the vehicle's value over time.
Knowing how much the car is worth and understanding the costs of repairs and maintenance can help you make an informed decision as to whether you replace the car or make repairs and keep driving it. In contrast, you can own a vehicle, personally, and take a mileage deduction. This is advantageous when you don't replace your vehicle often.
Chart of Accounts and Travel Expenses
If you travel with your business, a chart of accounts allows you to separate all the expenses involved. If you simply lump everything together as “travel,” you won’t know if you are tracking meals and entertainment, airline tickets, hotel rooms, shuttle rides, or parking tickets. Since there are different rules for how these items are deducted from your taxes, you may not be taking all the deductions to which you are entitled. You also may be making yourself vulnerable to fines, penalties, and closer scrutiny in case you have taken excessive, unauthorized deductions and are audited.
Debt and Taxes
If you are making debt payments, it is important to how much of the payments go toward the debt’s principal and how much toward interest, insurance, or other fees. Including the entire amount together on your taxes or other official documents could have severe negative repercussions, even if the inclusion was accidental.
Too Much of a Good Thing
It is really important to work with someone knowledgeable. Otherwise, you will default to simply tracking income and expenses. Or you could be like one of our clients who came to us after using Quickbooks for years. The company employed less than ten people. Their needs should have been pretty simple. However, they tracked each employee, each client, each investor, each vendor, and even the owner’s draws on equity in separate accounts. If we would have done a straight conversion of their Quickbook files to a chart of accounts, we would have had almost 700 accounts to track for this small business.
It’s important to track everything you need to track separately, but don’t separate everything into minutiae. Adding separate accounts every detail is tedious and expensive.
The Bottom Line
To really take the pulse of your business and understand how it’s doing, you can’t rely solely on your revenue and expense report. You should be tracking everything on a chart of accounts.
