If we think of accounting as a “place for everything and everything in its place”, then the Chart of Accounts (COA) is the place in “place for everything.” From a managerial accounting perspective, one of the most important tools to manage the finances of a company is the Profit & Loss Statement (this may also referred to as the Income Statement or the Statement of Operations). In order for this important tool to work correctly, the COA must be structured so that it reflects an accurate mirror image of your business.
Revenue is not just revenue and expenses are not just expenses.
This is where the architecture of the COA is very important. It must demonstrate what’s happening with the business, and allow for the measurement of “margin – mix.” If a business is selling products, services and parts, the income accounts must reflect that. Expenses must be separated between direct costs associated with sales and indirect costs which the business incurs whether or not there is a sale.
For example, in the construction industry: field labor, truck gas, cement, and sand are costs directly attributable to a “job.” Management salaries, office supplies, and utilities are indirect costs. The identification of the Profit Centers is essential to understand the relative gross margin contribution of each product line in order to offset fixed expenses and generate a net profit from operations.
If you can’t measure it, you can’t manage it. The architecture of the COA determines your ability to engineer your profitability by creating a valid multi-year strategic plan, generating a functional budget, understanding your true overhead allocation ratio, and pricing correctly. Having a place for everything is the starting point. Putting everything in its place guarantees the proper characterization of your financial data in accordance with the organization of your business.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
