Categorizing your accounting transactions is an important part of keeping accurate books that are useful to you and which follow good standards. But what pitfalls should you avoid as you create categories and charts of accounts for your business? Here are a few of the most common.
Categories Too Broad
Many companies start out using the standardized expense categories provided with their accounting software. While these are a good place to begin, they are a one-size-fits-all approach.
What makes a category too broad? In general, if you find yourself often having to refer back to original documents because you don't have enough details in the data entry, the category should be broken down further. For example, a company with high shipping costs may want to track incoming and outgoing shipping costs separately while one with only occasional shipping may not need that level of detail.
Categories Too Narrow
On the other hand, some companies keep adding categories until their chart of accounts is very lengthy and very specific. This slows down the entry process, though, because the staff is constantly searching for just the right codes. It may also unexpectedly cause even more inconsistency as accounts are duplicated or employees choose different categories each time.
The best way to prevent this unnecessary confusion is to put in place parameters for adding new categories. Only one person, for instance, might be authorized to add accounts. You might also only add these when a specific type of detail — for example, deductible taxes and nondeductible tax fees — is needed more than once. And a responsible party might analyze the chart of accounts once per year to weed out unnecessary accounts.
When determining how much of an invoice or transaction to break into multiple categories, there are two primary guiding principles. The first is cost-effectiveness. Breaking down one entry into several categories takes time and effort. Make sure the usefulness you get from it justifies the extra work needed.
The second principle is transparency and sound accounting. Lumping items into one category when they clearly should be broken down further skews the results and makes your financial statements less accurate. It could even appear that the company is either mismanaged or is trying to hide something.
Where to Learn More
Does your small business make any of these common errors? If so, you could be losing money, spending unnecessary time, or opening up yourself to problems. Start taking charge of your categories by consulting with a small business accounting service in your area today.