In March of 2015, Warren Buffet appeared on CNBC's Squawk Box - a morning news program that mainly discusses business and politics before the stock markets are open. During his appearance, Buffett, chairman of Berkshire Hathaway and probably the most recognizable billionaire in the world, made a seemingly small remark that has drawn much attention over the past few years:
Accounting is the language of business, and you have to be as comfortable with that as you are with your own native language to really evaluate businesses.
Accounting is the language of business.
The thing that all businesses have in common - every single company across the globe - is money. Cash flows into a business in the form of sales, it flows out of business for expenses or repayments of debt, and companies keep it in the form of Equity. Each of these activities is a short story detailing the way money moves.
All things in business eventually come back to money.
Therefore, money is the foundation of every financial story written in the accounting language. A clear and concise Chart of Accounts makes this otherwise complicated language easier to understand.
What is a Chart of Accounts?
At a basic level, accounting is a "system of accounts," each containing money. The act of "accounting" is the action of tracking how money moves between these accounts. The Chart of Accounts (COA) lists every account used within an organization's accounting system. It contains a high-level overview of every account name and the corresponding number, type, and typically the amount of money held within each account.
Having a well-organized Chart of Accounts is crucial. If it becomes too crowded, it's incredibly easy to get confused regarding what money goes where. When creating your accounting system, you should only use clearly defined accounts in your COA that help you understand your business from a birdseye view.
Accounts are like buckets; our Chart of Accounts is just a list of every bucket in the system. It turns out there are several different types of buckets, too. They all hold various things! The 5 basic accounts in a chart of accounts are:
Assets: An asset is something your business owns that has monetary value with the expectation that it will provide a future benefit. The most accessible type of asset to remember is money. Cold hard cash intrinsically has value. So, your bank account is an asset. Land, equipment and investments are all assets as well because they are a store of value.
Liabilities: A liability is a monetary value you are obligated to pay someone else, sacrificing economic benefit to other businesses. The most common type of liability? Credit cards. Credit is a promise to pay for something in the future - effectively an IOU. That means loans and other money your business owes to someone else is a liability.
Equity: Equity calculates the monetary value you have left over after all liabilities have been satisfied. Equity will always be equal to your assets minus your liabilities! For this reason, things like your net income or money invested into the business are forms of Equity.
Expenses: Who doesn't love spending money? Expenses are just that: monetary value your business spends in the form of cash or credit. Expenses are the most commonly understood type of account, whether it's that fancy lunch you bought the sales team or the computer purchase you made for your new team member.
Income: The monetary value that you receive in exchange for the goods or services you sell. Sales are the most common form of an income account. Every business needs income; no one can survive without it!
Let's recap what we have so far: we build accounting systems using a series of accounts: buckets that hold value. The Chart of Accounts is a long list of all the account buckets within a given system. Finally, there are five different types of buckets. Many businesses use an industry-specific Chart of Accounts to better understand their financial story.
The Best Chart of Accounts for Service Businesses
Every business is unique; therefore, every business owner needs access to different information. A concise and well-organized Chart of Accounts allows you as the business owner to understand the organization's financial health from a high level using your financial statements.
One of the most critical aspects of an effective Chart of Accounts is the accounts labeled Cost of Goods Sold (COGS). Cost of Goods Sold accounts are typically defined as expenses directly related to the item your business sells. For example, a camera company may choose to identify all of the different manufacturing components and the costs associated with producing their products.
Unlike inventory-based businesses, service businesses rarely have inventory to keep track of.
Graphic designers, photographers, mortgage brokers, and financial advisors sell intangible products. Since there's rarely inventory for service businesses, the chart of accounts can be much simpler! Identifying the Cost of Goods Sold related to your product is still important, such as web-hosting costs for website designers, because it helps to identify the profit margin you're receiving on the services you're selling.
When using any kind of Chart of Accounts template, it's essential to rename COGS accounts and income accounts to more closely match the type of products you're selling. For example, an auto modification shop may want to identify COGS accounts like "Equipment Costs," "Electrical Modification Costs," "Service Labor Income," and "Parts Income." By effectively breaking out and labeling each of those accounts, you'll be able to quickly identify and understand more information about your financial story.
Importing a Chart of Accounts to Your Accounting System
Most accounting systems such as QuickBooks Online and Xero allow you to upload a custom-based chart of accounts.
QuickBooks Online uses your chart of accounts to organize all your accounting transactions. QuickBooks does provide a standard Chart of Accounts template upon account creation. Still, it's much more effective to have a Chart of Accounts specifically designed and tailored to your business. It's easy to edit the Chart of Accounts directly in QuickBooks Online or any other accounting system. Still, importing a template Chart of Accounts Excel spreadsheet is much more effective.
To upload any Chart of Accounts template, you'll need to ensure that your spreadsheet is formatted correctly. Primarily, you should include an Account Name, Account Type, and Tax Type. Our pre-formatted Chart of Accounts template for service businesses can be used to easily and quickly upload directly to QuickBooks online or can be used to manually edit an existing Chart of Accounts.
Before uploading your Chart of Accounts template, make sure that you change the names of the relevant accounts (such as Bank Account #1) to match the names of your accounts accurately. This will ensure that you have minimal work after uploading the COA to your accounting system.
If you haven't manipulated a Chart of Accounts before, it's best to consult an accounting professional to ensure that your transactions are accounted for appropriately.