The finance and accounting functions are as dynamic as ever. There are a number of emerging and innovative applications for general ledger automation, real-time management reporting, and data mining for financial analysis — and that means business and operations teams are receiving better information more efficiently. However, even the best technology will stall without a well-designed chart of accounts (COA). Before you can consider investing in the newest accounting or reporting software, start by looking at your COA.
At its core, the COA is a list of accounts that comprise the financial records of the general ledger. The COA is often overlooked and taken for granted, and yet somehow it’s just as easily over-relied on and expected to contain all financial answers. To find middle ground, invest the time, energy, and skill to create a solid COA that leads to structured reporting and processes to help you make better business decisions.
Before creating or redesigning a COA, though, consider some common challenges and how to address them.
Balance detail with efficiency in your chart of accounts
The prospect of gaining detailed information is enticing. Unfortunately, in a general ledger, a continuous drive for detail can reduce accounting efficiency to a crawl. For a simplistic example, you wouldn’t order black pens and then create a pens — or even a black pens — account, as opposed to an office supplies account. In most cases, the extra detail in the COA does not bring additional value.
Instead of burdening your accounting system with unneeded detail, design your COA to operate at the intersection where decision making meets efficiency. If you don’t need the specific amount or category quickly on a routine, monthly basis, combine it with another account. A good example of this is utilities. Most companies need to know their utilities spending on a monthly basis, but few need the same visibility to the office gas or water bill. If you periodically find utility variances when compared with budget or historical actuals, the finance or accounting team can analyze the utilities components to determine the outlier and driver of the variance.
Be consistent across internal departments
For companies with subsidiaries or different locations, COA consistency can increase accounting efficiency among individual units. It can also enhance management reporting across the entire company. Without that consistency, one subsidiary with an overly complex COA may spend another headcount’s worth accounting for the same items that another subsidiary performs in less time. COA differences across the company also lead to inconsistencies in accounting policy. As a result, the CEO or board may not realize that a category or profit and loss line item may contain differences across each subsidiary.
Companies that acquire different businesses may do so over time and in unrelated industries, which often results in a separate, unrelated COA for each company. Adopt a standard COA that is slightly customized for the particular business unit to create an efficient company-wide accounting function. This standardization will ease the transition of future acquisitions and ensure they are measured accurately and consistently.
Connect the COA to your business model
As transactions are recorded, ensure the COA is directly related to your business model. If it’s not, you may find you’re separately tracking divisions, locations, or even cost centers within the accounting system. While your income statement may be complete in total, determining product or location profitability will be an extremely manual process, which can put you at risk for inconsistent and even inaccurate analysis (not to mention overworked accounting and finance teams).
Whether you use QuickBooks, SAP, or another web-based accounting software, take advantage of grouping conventions to properly segregate activities within a specific product category, location, or even reporting geography (e.g., sales and marketing, general and administrative, etc.). Using these best practices allows teams to focus on reporting and analysis, not manual manipulation and consolidation.
Understand the role of your general ledger
The chart of accounts is the foundation for building effective financial reporting systems. Yet many small businesses attempt to extract insightful analysis by only comparing general ledger accounts. They believe having an account for every potential expense or revenue item diminishes the need for analysis since they have visibility to all accounts at all times. While that premise may sound reasonable in theory, it is less than optimal in practice.
The first problem is that it significantly dilutes your transactions to where the monthly landscaping bill has the same prominence in the COA as sales commissions. Second, when evaluating overall operating expenses and postulating why sales and marketing expenses are higher than budget, you may find a considerable number of variances, most of which are insignificant in isolation. As a result, the accountants or bookkeepers spend considerable time recording transactions, and analysts have to almost work backward to get variances to a point where key drivers can be discovered.
Instead of relying on the COA to conduct variance analysis, develop an analysis process that works in conjunction with the accounting period close. Rather than reviewing specific accounts and investigating $100 differences alongside $100,000 ones, empower the finance or accounting team to present financial statements along with commentary and analysis on key drivers. This allows you to focus on chronic overspending or underachieving operations, rather than investigating an extra $200 spent on office supplies.
How we can help
Both established businesses and start-up companies alike benefit from a well-designed chart of accounts. Although the process for building or redesigning the COA can be time-consuming for both the financial and operations teams, the payoff is efficiency and the foundation needed to transform the accounting and analysis function.
CLA supports the entire accounting and finance infrastructure. Our professionals use their experience and industry-specific benchmarks to build and redesign the type of chart of accounts that fit this purpose. An outsourced CFO or controller can work directly with you to understand your company and your business model. We apply our experience building a chart of accounts that modernizes and positions your accounting function to drive growth.