What do Grocery Stores have to do with your Chart of Accounts?

Posted on July 27, 2020 by John Lanahan

If you ran a grocery store, would you randomly place items on shelves? Or in the order they were delivered off the trucks? Obviously not. This would create a poor customer experience for confused patrons as they wander your store aimlessly looking for their groceries. But this is what many small businesses do with their Chart of Accounts. They simply create a long list of accounts with little or no organization or add new accounts as new expenses come through. In the same way a customer needs to quickly find their favorite cereal, companies need to find important financial information in a timely manner. Think like a grocery store when organizing your Chart of Accounts! Here’s how. 

So what is a Chart of Accounts (COA)?

Very simply, a COA is an index of all the financial accounts in the general ledger. These accounts are broken into categories and subcategories. Ultimately they serve as the foundation of your financial statements. Structuring them appropriately provides clarity when providing insights to your financial statements and company performance.

A COA is broken down into five core sections that correspond to the Balance Sheet and Income Statement:

  • Balance Sheet: Assets, Liabilities, and Equity Accounts
  • Income Statement: Revenue and Expenses

Structuring your COA

There are many different ways to approach structuring your Chart of Accounts. You could get extremely complicated and granular, but for the non-accountant, it’s best to think about your business conceptually first. Then build your COA to fit how you analyze your business. Start by drawing flowchart to group accounts logically, then number and group them later. Here’s one process to develop your COA:

1. Revenue Streams  

Start with the most straightforward and understandable piece of your business. How do you make money?

  • Operating Revenue – Start with your Operating Revenue or the primary ways your business generates revenue. You also want to group your discounts and returns with sales to calculate your Net Revenue. Under the parent sales account, you will add sub-accounts for the various revenue streams:
      • Sales Account
        • Revenue Stream 1
        • Revenue Stream 2
      • Sales Discounts
      • Sales Returns and Allowances
      • Recurring and non-recurring revenue – When developing your Sales COA, make sure to breakout accounts for recurring vs. non-recurring streams. Categorizing your monthly subscription or yearly contracts vs. one-time projects or one-off sales creates a better structure for metric reporting and building budgets and projections.
      • Non-Operating Revenue and Gains – Next, evaluate if there are other ways your business generates income from non-primary activities. Non-operating revenue accounts include all types of income that you receive that are not part of your main line of business. Many of these items will go “below the line” to a group on your P&L that comes after your EBITDA or Net Operating Income. These may include:
        • Interest Income, Dividends, Commissions, Rental Income, Gain On Sale Of Assets, Other Revenue

2. Defining Cost of Goods Sold and/or Cost of Sales

One of the biggest issues with the Chart of Accounts is a mislabeling of direct costs associated with generating revenue and mixing up indirect costs associated with running the business. To solve for this, first, define direct costs that are associated with the delivery of product or service:

  • Examples: Materials, labor, shipping expenses, and subcontracted services are all examples of direct costs that may ultimately be included in your direct costs.
  • There is some nuance depending on your business, especially with service companies. For example, typically accounting wages would go into Operating Expenses since they are part of running the business – not delivering sales. At Compass East, however, accountants and financial professionals are the core function of delivering our product and service.

3. Operating Expenses

Once you’ve defined your business direct costs tied to the delivery of service or goods, next focus on grouping your operating expenses. These are the costs tied to running your business.

  • General and Administrative (G&A) – Expenses related to the general operations or overall administration of the business.
    • Personnel expenses – How much money are you paying your employees? All of your non-labor and sales-related wages, benefits, and bonuses would be calculated in personnel. 
    • Professional Fees – What outside services are you using? Legal, accounting, consulting, etc. will be categorized as Professional Fees. 
    • Supplies – Office supplies, postage, printing, and other office expenses.
    • Other General and Administrative – Items that don’t necessarily fit into the other G&A categories. Bank service charges, merchant fees, and miscellaneous items.
  • Computer Hardware/Software – Historically, hardware and software costs would be allocated within G&A (and you still might depending on the business). However, as business becomes more reliant on technology and replaces traditional overhead, it could make sense to separate hardware/software out on it’s own group. Segmenting this from your regular G&A is advisable.
  • Occupancy – Occupancy costs relate to your facility leases and rent, as well as the related utilities, telephone, internet, furniture, office equipment leases.
  • Other Overhead – These are your “necessary to operate” business costs like insurance, business licenses, permits, and operational state and local taxes.
  • Selling Expenses – Selling Expenses are the costs related to making sales (different than delivering service in COGS/COS).
    • Examples: Salaries & wages for salespeople, advertising, travel, entertainment, advertising, marketing spend, commissions etc. These are important for calculating the cost of customer acquisition.
  • Non-Operating Expenses and Losses
    • Donations, penalties, and fines, interest, federal income taxes (for corporations)

4. Balance Sheet Groupings

Now that we’ve grouped accounts based on the Income Statement side of the financial statement based on how you logically operate the business, the balance sheet is the last step and is a bit more straightforward

  • Assets – You will have accounts for all of the company’s assets.
    • Examples: Cash, cash equivalents, assets, fixed assets, real estate, accounts receivable.
  • Liabilities – Accounts for anything your company owes:
    • Examples: Current liabilities, debt, lines of credit, accounts payable, wages payable, etc.
  • Equity – Shareholder value, essentially anything that’s left over once you subtract liabilities from assets. This is the value of the company owned by founders, employees, and investors.
    • Examples: Common Equity and Preferred Equity, Additional Paid-in Capital, Distributions/Dividends and Retained Earnings

Now that we’ve grouped all of our accounts according to operations, it’s time to number them.

5. Numbering your Accounts

Going back to our grocery store example, when you start to organize groceries by logical grouping, you start to number aisles, rows, and sections of the aisle. Seems pretty straightforward but many companies create accounts without a coherent numbering system. Sticking with this analogy, the first step would be to number the “aisles” or the major accounts that we walked through above:

The best practice is to use: 

  • 10000s for asset accounts, 
  • 20000s for liabilities, 
  • 3000s for equity, 
  • 40000s for sales, 
  • 50000s for direct/indirect costs, 
  • 60000-70000s for operating/overhead expenses, and 
  • 80000-90000s for non-operating expenses such as donations and interest, and for non-cash expenses such as depreciation.

Allowing for additional zeros when creating the parent accounts, will provide flexibility as you need to add new sub-accounts over time. 

Why does any of this matter? KPIs

Quickly accessing financial information is extremely difficult if you don’t have the proper financial infrastructure in place. Especially if you are developing leading and trailing KPIs and key drivers for your business. If grouped poorly, your KPIs reporting will be difficult, time-intensive, and inaccurate. And, the headaches of KPI reporting leads to the anxiety of operating blind. 

It’s time to reorganize your Chart of Accounts like a grocery store! Start conceptually and organize your accounts logically. You don’t need to get too granular as more complexity actually decreases how informative your COA is. Only create a new account when there’s something substantial to track! A great COA will be invaluable as you quickly need to access financial information. As always, Compass East incorporates Chart of Accounts redesign into almost every implementation we do. Starting from the bottom-up will save you significant time in the long-run!

Questions? Finance and Accounting needs? Schedule a Free Consultation today!


John Lanahan
Director Of Financial Strategy
john.lanahan@compasseast.com