When a business makes a sale, purchases new computers, pays employees or takes a loan from the bank, all these financial transactions must be recorded. And that’s where a chart of accounts comes in. A chart of accounts organizes all the company’s financial accounts, so that similar transactions can be categorized accordingly. This in turn helps create the company’s financial statements such as the income statement and balance sheet.
There are 5 sub accounts to a chart of accounts:
- Assets – This is what a business OWNS such as inventory, office equipment, and cash.
- Liabilities – This is what a business OWES such as wages, credit card balances, and loans.
- Equities – The difference between assets and liabilities.
- Income – This is what the business EARNS such as sales, consulting fees, and investments.
- Expenses – This is what the business SPENT such as marketing, travel, and training.
The assets, liabilities, and equities sub accounts flow into the balance sheet. The income and expenses sub accounts flow into the income statement.
All chart of accounts will have the same basic skeleton with the 5 sub accounts, however, no two chart of accounts are exactly the same, as no two businesses are exactly the same.
It’s important to set up a chart of accounts properly and to do tweaks as the business changes. It makes it much easier to create financial reports for a snapshot in time where the business can use it to make decisions.
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