What the Heck is My Chart of Accounts?Posted on September 6th, 2021
A friend of mine who teaches “Entrepreneurship” at a local college recently shared my blog articles with his students. He subsequently told me that while they found these articles interesting, the one thing they all seem to struggle with is the concept of the “chart of accounts,” and he suggested that I write an article on that topic.
Well, this topic really goes right to the core of all the other articles I’ve written. If you don’t understand what your chart of accounts is, you’re certainly not going to understand anything else about accounting and finance.
To put this into perspective, let’s relate it to your personal financial information. As an employee, you receive a paycheck, right? This starts with a gross salary or hourly wage offered to you by your employer. From there, your employer must deduct federal withholding taxes, and social security and Medicare taxes, resulting in your net paycheck.
From your net paycheck, you then have various living expenses such as rent, utilities, telephone, car payment, food, and of course, beer, etc. You get the idea. You may also own your own home, in which case you likely also have a mortgage loan and a mortgage payment instead of rent. If you then subtract all these expenses from your Net Paycheck, you end up with what you might think of as your “Net Income,” which is then available to go into your savings account (or more beer if you choose). But if your expenses exceed your Net Income, you either become past due with creditors, or you need to cut back on your beer drinking or other discretionary spending.
A business has a similar situation. It’s “gross income” would be its sales, from which it then subtracts all of the various expenses it incurs to be in business. If it does things correctly, the bottom line will be its Net Income or “Profit” which can be invested into a savings account, or, back into the business to buy more inventory to grow more sales, for example. But if it does things incorrectly, it incurs a Net Loss, and if this goes unchecked, the business may not survive.
What I have described so far is your Income Statement, or in the case of a business, its Profit and Loss Statement. In addition to this, you also have a list of assets you own, and liabilities you incurred to purchase these assets. The difference between the two is your “Equity” in those assets. In the case of a business, this becomes its “Balance Sheet,” or “Statement of Financial Condition.”
To sum up, the list of all of the above income, expenses, assets, and liabilities, are what becomes a business’ “Chart of Accounts.” Yes, it’s really that simple. Below is a sample of what this all looks like for a small retail business: