Properly categorizing expenses in your business is essential to producing meaningful financial records. Your expenses is part of the chart of account. The chart of account is the way your financial statements are organized and should capture relevant events for your business. Your expenses should be divided into accounts that can help you make quick decisions. Think of a chart of accounts like folders on your computer. Each folder in your computer holds information about a certain topic. In the same way a chart of account is like the “my document” folder and under the document folder are different folders and files.
To categorize expenses, you must identify all processes involved in your business and assign it to an account. There is no hard fast rule on how your chart of accounts should be coded. However, it will be easier for the business if there is consistency in the choice of names.
When developing a chart of account, less could sometime be more. Unless you need to track an expense specifically, most expenses could fit into a much larger category. The less accounts you have, the better you can wrap your hands around your business. But on the other hand, a chart of account that is so concise will not provide enough information. The objects you choose to track all depends on what information you need for decision making.
Steps to categorizing expenses in your business
- Identify all the processes involved in your business
- Assign a cost to all the processes and give each process a name.
Example of categorizing expenses in your business.
George is a lifestyle entrepreneur and designs websites for other entrepreneurs. To properly classify expenses into meaningful categories, George takes the following steps:
Identify all processes in his web design business
- George places ads in various places to get new clients – Advertising expense
- After a client contacts him his virtual assistant sends out a proposal – Outsourced labor
- If the client accepts a proposal he sends out an invoice from his online software – Dues and subscription
- He has other online software that helps him do the job – Dues and subscription
- He goes to conferences to update his skills – Education expense
- He attends networking events to meet new prospects – Networking expense
- He pays to host his own website – Hosting fees
- George pays his CPA for maintaining his books monthly and doing his taxes – Accounting fees
- Occasionally, he takes a client out to discuss business – Meals and entertainment expense
Once George has identified his processes he can then choose how he is going to categorize transactions so it makes the most sense to him. For instance, George could choose to combine advertising and networking events as marketing expense. In other words, he will have an expense called marketing and under marketing will be 2 sub accounts named advertising and networking.
Here is how George chooses to categorize expenses so it makes the most sense to him:
|Salaries and wages ( George also pays himself)|
|Dues and subscription|
|Other dues and subscription|
|Meals and entertainment|
There is no one right way to categorize transactions it all depends on your business needs. Feel free to ask me any questions you may have about categorizing expenses in your business.