A chart of accounts is considered the heart of every business’ financial management. The functioning of a chart of accounts plays a crucial role in the financial management of different businesses.
Definition of Chart of Accounts
The Chart of Accounts is an important tool in any business. It helps businesses track their revenue, expenses, and profits. Tracking the position of the business plays a significant role in the management of the business. It helps to understand how the business is performing financially. Knowing the financial health of the business is important for business owners as it helps them to know the accurate flow of money in the business. Analyzing the financial data also helps in understanding where they are lacking an effort. This will provide an opportunity for business owners to improve their finances.
Proper financial management is important for firms as it helps them to achieve their objective in the business. Through these insights and data, business owners can also comprehend the performance of their business and picture their further plans as well. Being aware of the business finances will also help you to make informed decisions regarding the growth or expansion of the business in the future.
Functioning of Chart of Accounts (COA)
One major part of financial management for businesses is recording every transaction incurred in the business. This is done through the process of bookkeeping. Money flowing in and out of a business is important to track because it can help identify opportunities for growth, which is what a business strives to do. In fact, tracking the money flow can be used to generate new ideas or assess how well the company is performing.
All these transactions are further categorized according to their accounts and sub-accounts. This helps in organizing the books of business. Segregating all the transactions of the business into various financial categories makes it easier to understand the financial performance of the business. This helps you in keeping your business books well organized and comprehensive. This categorization of accounts is done with the help of the Chart of Accounts.
The account and sub-accounts among which all the business transactions are recorded are located in the chart of accounts. The balances of all these accounts are mentioned as well under the chart of accounts.
Types of Accounts under COA:
A typical chart of accounts has five major types of accounts. They are:
Assets
Assets are tangible and intangible resources that an organization has to offer. Assets can be anything from a company’s product, design, brand, or service. Assets are used in the business world to increase revenue and gain a competitive advantage.
Liabilities
Liabilities are a part of the accounting process. They are the obligations that an entity must meet to remain solvent. The liabilities of a business can be classified into current and noncurrent liabilities. Current liabilities are those liabilities that must be paid within one year. Noncurrent liabilities are those that have a longer time for payment, but they must be paid eventually.
Equity
In business, equity is the value of a company’s assets that is not paid for by debt. Equity can be thought of as a company’s financial worth. The idea behind an equity offering is to raise money for a new business venture without having to go through as much debt as is usually required for such undertakings.
Expenses
Expenses are a part of every business and they can be tricky to manage. It is important for businesses to understand the types of expenses that they incur so that they can make the best decisions about their business. Business expenses are any costs that are incurred by a business during its operations. It includes costs related to production, marketing, human resources, sales, and distribution.
Revenue
Revenue is a key metric in business. It is the amount of money that a company generates, and it is one of the most important metrics for businesses. The importance of revenue in business cannot be overstated. Revenue is what sustains a company, which in turn contributes to its growth and success. Revenue can be broken into three categories: sales, cost of goods sold, and gross margin.
Various businesses may add a few or more accounts to this list as per their business needs. But in general, all the transactions incurred by any business are categorized among these five accounts only. These accounts are also named numerically or alphanumerically to ease the locating of accounts in time of need. These numeric values are based on the need and requirements of the specific business.
Once all the transactions are incurred in the books by bookkeepers, they are segregated among a chart of accounts to simplify the process further. Next to every account and sub-account, there is a “View Register” option which allows you to access all the transactions that have been registered under that specific account or sub-account.
Overall, in the business world, there are many ways to manage your finances, but one of the most important tools for managing your money is the Chart of Accounts. This tool helps you track income and expenses so that you can make better budgeting decisions.
COA helps business owners to structure their finances in a logical and precise manner. Further, it simplifies the process of locating accounts as well as the further process of accounting. A Chart of Accounts acts as a framework for business transactions.