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More Than a General Ledger: Why the Chart of Accounts Is So Important to Your Business

Posted by Stephen King
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Chart of Accounts

THE TELLTALE SIGN YOUR CHART OF ACCOUNTS IS NOT DESIGNED FOR MANAGEMENT REPORTING

If your chart of accounts reads something like this, "Accounting, Advertising, Bad Debt, Commissions...Yes-Men, Zebras," then it's set up alphabetically to streamline compliance and tax filing, but not to facilitate management accounting. When set up alphabetically, it's a red flag that your chart of accounts is likely only being used for tax and compliance purposes.

In a classic chart of accounts, oriented for taxes and compliance, payroll is not separated into cost of goods sold (direct expenses/above the line) and overhead expenses (indirect expenses/below the line).  Payroll is often represented as an individual line items on an income statement. This is fine for general compliance, but not helpful when it comes to management reporting.

Representing all cost-of-goods-sold and overhead expenses as single numbers does not allow you to break down your payroll expenses and actually understand where the business's money is going – how people’s time it is being spent, where money can be saved or whether the company is getting any return on investment from its biggest expense, its people.

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THE BIG THREE: HOW TO SET UP A CHART OF ACCOUNTS FOR MANAGEMENT REPORTING

When organized to facilitate management reporting and management accounting in QuickBooks, a chart of accounts breaks indirect (overhead) expenses into three main categories divided by expense type (under the three expense types, individual line items may be alphabetically arranged).

1. Customer Acquisition Costs (CACs)

Customer acquisition costs – the amount of money spent on acquiring new customers – include all sales and marketing expenses. Sales and marketing are different functions and should be separated into two categories. These includes salaries, commissions, out of pocket expenses, marketing agency fees, dues and subscriptions.

By documenting these costs in your chart of accounts, you can use your contribution margin to determine your break-even point on new customers (the point at which the customer has generated enough revenue, that the acquisition cost has been covered).

2. General & Administrative (G&A) Expenses

Often referred to as a business's "nut," these are your company's “lights-on” expenses. So, G&A expenses cover the amount it costs to run your business at the beginning of the month – without a single sale, customer acquired or any revenue generated. These fixed costs include non-discretionary items such as your phone bill, rent and utilities.

Being able to analyze your general and administrative expenses helps you determine your company's break-even point or the amount of profit needed to "cover your nut." These expenses are the bare minimum that a business can cover to remain in business (without re-investing money to generate more profits).

3. Product & Industry Expenses

These are your research and development (R&D) costs and are mostly discretionary expenses (meaning you don't have to pay for them to stay open) that help your business be competitive within its industry. R&D costs include expenses such as attending industry conferences and trade shows, employee professional licenses and continuing education, software licenses used for testing new products (not generating revenue and not billable to a client), magazine and journal subscriptions and membership dues.

These expenses are indirect and discretionary because they do not directly generate revenue for your company, but they are the expenses that keep your company competitive in the market and should be tracked individually to help determine return on investment.

HOW YOUR CHART OF ACCOUNTS CAN HELP YOU SECURE PRIVATE EQUITY VENTURE CAPITAL

Businesses seeking outside investors always have a financial projection model (forecasted budget and plan) which is used as the basis for attracting investors. Potential investors consider these models, looking for growth potential and sound financial management.

A chart of accounts set up for management reporting should exactly mirror the company's budget, making it simpler for both business owners and investors to make direct comparisons of financial projection models against the actual, historic numbers – once actual results have been recorded (bills and payroll have been paid and invoices have been sent).

GrowthForce's system development methodology starts with the end of each financial period in mind, when establishing financial projection models and organizing the chart of accounts. Side-by-side, the chart of accounts and the financial projection model quickly reveal variances between the forecasted (budgeted) and actual expenses. Investors and business owners, alike, can then use these variances to determine what drives growth in the business (i.e. the business's drivers).

Having a chart of accounts that mirrors the financial projection model makes it easy to see variances between the actual results and budgets and can provide answers to several questions. For example, a company with a missed sales target can answer questions, such as:

  • What assumptions were made when establishing the sales target?
  • What were the actual results?  How many sales proposals were made?
  • What was the average conversion ratio of sales to proposals?
  • On average, how many sales were made per proposal?

With these questions answered, you can adjust your company's financial projection model or make adjustments in operations, pricing or sales and marketing to better project growth and meet financial projection models, with respect to all three categories of your chart of accounts, during the next financial period.

With a solid financial projection model and a chart of accounts designed to deliver actionable financial data, you can wow investors during your company's next pitch or round of fundraising, or better yet, make better strategic decisions that drive growth.

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