Financial Understanding starts with the Chart of Accounts

We are about to discuss accounting matters.

Hey, don’t click past, it really is important!

Well yes, a little boring too, but sometimes you need to get into the detail of the boring to get the information you need in order to do all the glamorous stuff like building a vibrant business. In fact often you need to get into details to make sure your product or service delivers its promise. Think of a mechanic – no point creating a culture of caring for the customer if your mechanics fail to bleed the brake valves every time. Or a lawyer who’s innovative and really digs deep for the client – not proofreading and the typos will get him every time.

So, one of the crucial (boring) details in any business is the accounting. You can hire a tax accountant at the end of the year; you can hire a once a week book-keeper; you can even employ a full time accounts-person and buy an expensive accounting software system; but the decision about some detail must lie with you and while you should take some of their advice, you need to decide on some key elements of your books.

The one particular aspect I want to discuss with you today is the creation of a “chart of accounts”. This is accountants’ speak that means identifying the categories you want your transactions classified into. The category “Sales” is a good example. You may decide on a chart of accounts that just contains the category “Sales” in the income section, or you may decide to have categories “Sales – retail”, “Sales – wholesale”; or you may decide it would be more informative to have the categories “Sales – Product A” and “Sales – Product B”.

The reason you must be involved in this, although your accounts person is more than capable of creating these account-transaction categories, is that you need to decide on what information you would like from your accounts. If all you are interested in is how much you took in during the week, then “Sales” will do fine, thank you very much. But consider, how much more can you do with information that tells you what proportion of your sales that week came from retail as against wholesale customers, or if Product A is outselling Product B so that you can investigate why?

One of my clients was a Not-for-profit based in a remote regional town. Their new CEO who on starting, set an agenda to impose a strong executive management initiative so worked with his team on “working proactively with the Board”, “understanding priority community initiatives and finding the right metrics for them” and so on. All excellent work.

However he also decided to overhaul the old accounting system and hired a new accountant. In his style of trying not to micro-manage, he asked his accountant to design the system. Again, well and good, except that in this case he didn’t explain how he wanted his cultural changes to be reported in accounting terms, in fact probably didn’t see how they related.

So, the accountant, with the CEO’s agreement, decided to code all Travel & Accommodation charges by Consultants into one category called “Consultants”. The theory was that since the NFP was trying to create in-house capacity this account category would tell them how much they were spending on external consultants, and they could measure usage through the year.

Unfortunately, this category of “Consultants” not only included very diverse types of consultants (lawyers, management consultants, architects, town planners, computer consultants) some of which were not envisaged to be replaced by in-house capacity, the category also included the Travel and Accommodation costs of some of these consultants because they came from the capital city, but not of others because they were local.

When I realised this I asked them a series of questions:-

1. How much are you spending on the skills you want to bring in-house versus those you know you will always outsource?

2. Who are the more efficient consultants – those from the capital city or the local ones?

3. How much is your Consultants budget affected by changes to airfares and hotel costs?

Clearly they were unable to say. Clearly in trying to make decisions about their consultants they could not compare apples to apples.

So, assuming most small business owners are not graduates in an accounting degree, what do you need to do to get the right information from your books?

1. Sit with your accountant and discuss what he or she suggest as your main account categories;

2. Decide what you need to know about your business – how each category of sales is performing, or what type of expenditure you want to compare?

2. Look at the suggested categories and ask yourself if any of those categories should be split further to give you information you needt;

3. Ask your accountant to show you a “dummy” set of financial statements with the categories you decided upon, and see if they make sense to drill down for more information from there.

Get it right up front and a lot of your decisions that you will need to make to grow your business can be resolved from the boring set of accounts.

Tell me what you think. Do your books give you useful information or are they simply a collection of numbers you don’t understand?