October 25, 2016

What Is The Chart Of Accounts – And Why Is It So Important?

debitandcreditconventionsWhen I teach in-person food entrepreneurship courses, I always talk about the importance of getting your accounting system in place. A big piece of that is making sure that you understand what the Chart of Accounts is and that, regardless of the accounting software you use to track your revenue and expenses, that you make sure that Chart of Accounts is set up correctly. This is one of those areas that I absolutely believe it’s money well spent to consult with an accountant even if you intend on doing your own bookkeeping on a regular basis. Why? Well, let’s talk about that.

The Chart of Accounts helps to categorize your revenue and expenses and, basically, makes sure that what you’re inputting into the software program is being accounted for correctly. Most software programs are set up to address the needs of a brad range of businesses. That means that your software program most likely doesn’t automatically know that as a food entrepreneur the items you purchase from XYZ retailer are ‘Ingredients’ or that, in your case, all those things that fall under the classification of ‘Ingredients’ should be considered ‘Cost of Goods Sold.’

Depending on the complexity of your business, your Chart of Accounts could contain dozens or even hundreds of categories but, at the end, they all must be funneled down into Revenue, Expenses, Assets, Liabilities, and Cost of Goods Sold (and potentially others depending on your business).

If your Chart of Accounts isn’t set up correctly to reflect what categories you make purchases in and derive revenue from, that will throw off all of the reporting in your accounting system. This means that the financials you look at be inaccurate, and to the extent you utilize them to make business decisions they can be misleading. This is a big issue in-and-of itself because it means that all of your numbers may be inaccurate. You can’t possibly make smart, strategic business decisions based on faulty numbers.

Equally, if not more, important though is the fact that faulty reporting means that all of the reports you pull from your software program with which to file your business taxes could also be incorrect. That could lead to an audit, fines, or more even if it was an innocent mistake.

As a reminder, I am not a CPA so this is not intended to be accounting or tax advice. I do however, recommend that all entrepreneurs consult with a CPA when they are getting started (or if you haven’t done so and are already up and running, better now than never!) to ensure the chart of accounts correctly reflects your business’ specific needs. Money spent on a good accountant is something you’ll never regret and a far better alternative to dealing with the IRS for an unintended mistake in your accounting.

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