5 quick tips on setting up your profit & Loss / chart of accounts.

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How should I set up my chart of accounts?

When starting a new business one of the first tasks you will take on your strategic journey will be to set up a chart of accounts in your accounting system. This will shape your financial statements for years to come and will determine how your financial information is collated and presented.

Your accountant should work with you to find a balance between what works with the management / owner and what is common place in the accounting and tax world. If you are not a publicly listed company you will not have to present your financials in accordance with IFRS accounting standards so you basically have free reign.

Here are my 5 tips for setting up your chart of accounts.

1. Talk to your tax accountant and see what line items they need to see separately.

This might be biased because I am a tax accountant, but it is also very important for end of year procedures and monthly/quarterly compliance.

For example starting January 2021 the Australian taxation office will allow small businesses to instantly deduct all assets purchased for under $1,000 anything above must be allocated to the balance sheet. In this case it would be beneficial to have an account for assets under and over $1,000.

Meals and entertainment for client meetings are not deductible whilst food bought for advertising purposes or whilst at business development seminars may be fully deductible. This is another example of when it would extremely beneficial to have separate accounts.

2. Decide whether to categorize by nature or function.

If you pay a contractor to run your google ads is this a marketing expense or a contractor/payroll expense?

The truth is its up to you as they will both get deducted for tax purposes. categorizing the expense by nature would be as a 'contractor expense' categorizing the expense as a 'marketing expense' would be categorizing by function within the business.

At CTK Accounting we would generally advise to categorize by function if you are hungry for growth as this provides great transparency on how different facets of the business interact with each other for example how advertising expenses effect revenue or how increased revenue effects cost of goods sold.

3. Keep it simple.

Set up just enough income, expense and balance sheet accounts to capture and purvey the information needed in a meaningful way.

The more accounts you add the less gravity each account will have and the more tired your eyes will get each time you scan your financials.

4. Only change or add accounts when absolutely necessary.

Once a business begins to build up a track record it will be important to  perform routine trend analysis to pick up unusual variance in different income or expense accounts.

If your chart of accounts in Quickbooks or Xero are forever changing it will make it hard to spot important changes which are affecting your business's profitability or strategy.

If you want to be able to reliably track KPI's and minute changes in your operating efficiency, keep your chart of accounts as consistent as possible.

5. Create sub accounts and tracking categories  

Sub Accounts are a must, they keep related accounts together and create totals for the grouped accounts, for example your profit and loss will show travel accommodation, travel meals and travel vehicle rental with a total at the bottom showing the sum of all travel accounts. Sub accounts keep your P&L neat, easy to read and give valuable detail.

Tracking categories in Xero or 'Class' tracking in Quickbooks can be extremely valuable if your business has multiple core profit generating units or multiple locations. These will allow you to view your profit and loss statements in a way which breaks down profitability by location or business unit such as manufacturing, installation or supply only.

However beware of creating class or category tracking unnecessarily. Once you start it you will have to assign a category to every transaction you enter in the future. So only start using this function if it is necessary and will be adhered to religiously.

Australian business who needs help setting up their accounting system and making sense of your financials?

Contact CTK Accounting HERE We are a Corrimal based accounting firm servicing clients in Wollongong, Sydney, Melbourne and California.

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