Your organization’s Chart of Accounts is the building block for meaningful financial reporting. Optimize it and your accounting data will tell you the truth about what’s really going on.
It will allow you to develop and track key performance indicators; it will tell you what you are doing wrong; it will highlight your financial successes; and it will give you the data to make better management and operational decisions.
If your Chart of Accounts is ignored or neglected, it will be like a weed that grows uncontrollably and takes the garden over. Your data will yield bloated and confusing results, lend itself to increased human error and, consequently, will provide incorrect conclusions that are useless to the leadership team.
Without financial data that can be trusted and understood, it cannot be relied upon to make the best objective decisions for the organization. Therefore, decisions will tend to be more subjective in nature and less effective.
So, What is a Chart of Accounts?
It’s nothing more than a list of accounts that classifies financial transactions into meaningful and digestible categories. A typical Chart of Accounts is comprised of asset, liability, net assets, revenue and expense categories. These categories should always be relevant to the organization’s operations. That’s it! It’s simple. And the simpler it stays, the easier it is to use.
For example, if revenues come from donations and grants, there should be an account for donations and an account for grants. If expenses are most commonly salaries, payroll taxes, rent and utilities, there should be an account for each. The exact name of the account is unimportant. What is important is that the name is easily understood. For example, if “Gas and Electric” is more easily understood than “Utilities,” then name the account Gas and Electric to ensure the data is as accurate as it can be. The right Chart of Accounts can help you gauge income and expenses clearly.
Another example is benefits costs. If health insurance has its own account, it’s easier to see if those costs are climbing at an accelerated rate. If they are, maybe it’s time to put the contract out to bid or to increase the employees’ withholding. Either way, there’s no way of knowing when you cannot track the data.
Can You Go Wrong?
Absolutely! The biggest mistake nonprofits make is that they create too many accounts. To continue with the example above, some organizations are not content with a “Utilities” account. Instead, they want:
That’s six accounts instead of one, which may not seem like a lot until it’s replicated over and over again. Suddenly the Chart of Accounts is excessive and the financial data is unwieldy.
And here’s what’s wrong with that…
A Chart of Accounts is nothing more than a list. If there are 400 accounts, there are 400 items on the list that every budget manager is expected to use. They then receive an invoice to code. To do that, they must scroll through 400 accounts to find the correct account for that particular invoice. Human nature is such that their attention span will wane; they’ll become impatient and they’ll be far more likely to pick any account rather than the correct one. The result is the data begins to lose its value.
Financial reports are run off the data from the Chart of Accounts. With errors in expense coding due to bloat, it is difficult to determine if too much is being spent on office supplies or advertising or if something was miscoded to one of those accounts.
Before adding accounts, consider the value each new proposed account will bring. Continuing with the Utilities example, in most cases the largest dollars will be spent on Gas and Electric. The remaining categories will be a fraction of the total. So why not call the account Utilities and code all 6 expenses there? If the total in Utilities is $1,000 and $900 of that is Gas and Electric, would knowing what comprises the remaining $100 really make a difference in the choices a decision maker makes?
It’s also not uncommon to see redundancies such as one account for Medicare and one account for Social Security (FICA), rather than combining the two into one called “FICA and Medicare.” Or it’s common to see one account for office expense and one account for office supplies. Does any of that additional detail change anything? Often, the answer is no.
A good Chart of Accounts is efficient, simple, and easy to understand. It contains just enough but not too many accounts. It’s like the foundation of a house. Take the time to build properly and it will serve the organization well for decades.
If you need help setting up an efficient and effective Chart of Accounts, our team of expert nonprofit accountants can help! Reach out to Chazin & Company to schedule your free consultation.