A Chart of Accounts is defined by Investopedia as
A chart of accounts (COA) is a listing of each account a company owns, along with the account type and account balance, shown in the order the accounts appear in the company’s financial statements. “Chart of accounts” is the official accounting term for the display of this information, which includes both balance-sheet accounts and income-statement accounts.
We can think of an account as a holding bucket. We can create several of these buckets for various things. Each transaction a business does is then categorized into one of these buckets. We can then get an idea of the company’s financial health by how much is in each bucket. A very simplistic COA would have very few buckets but information available is also minimal.
For example, let’s take a fictitious company Acme Widgets. This company makes three different types of products. It has an inventory of 12 parts used to make those items. We have three buckets:
- cost of goods
We can then take sales minus cost minus expenses and get profit (or loss). We can then determine the financial health of the company.
Does this tell us what we need to know? Maybe, but what if we are posting a loss? What do we need to change to get profitable? Wouldn’t it be nice if the COA contained three buckets for sales, and 12 buckets for the cost of goods? We then add in additional buckets for expenses, one for electric, one for gas, one for advertising, one for insurance, etc.
From this we could tell what the profit was on each of the three items. Maybe one of the items needs to go away, or maybe all are profitable, but we need to increase sales of one of the items. We could tell if we should rate shop our insurance plan or maybe we need to purchase a new vehicle if the expenses on the old is dragging us down.
Creating a chart of account specific to your business takes work to set up and more work to maintain but in the end, it can mean a more profitable business.