Elegant Chart of Accounts: Simple Can Be Sophisticated

• June 5, 2019
• Curtis Klotz

Previously in the Elegant Financial Systems series, Kathy Jastrzebski and I traded blogs sharing the principles and practice for developing Elegant Cost Centers. We urged you to define the largest, most organic categories into which your mission work naturally organizes itself and to design your cost centers, departments, programs, or funds to mirror that structure. Now we’re turning those same principles on your chart of accounts. The goal is to develop a chart of accounts that remains as simple as possible while still capturing all of the information necessary for you to run your nonprofit well and to successfully share the story of your organization’s financial health.

Applying the elegance principles always starts with a version of the same two questions. When considering what to include in your chart of accounts, ask:

• Is this particular component of the system (line item) absolutely necessary for you to manage your organization and make important strategic decisions?
• Is this particular component of the system (line item) absolutely required by outside users of your financial and organizational data — donors, foundations, government agencies, regulatory agencies, nonprofit watchdogs, or community members?

Avoid Line Item Proliferation

By holding yourself to the elegance principles, you can avoid overcomplicating your chart of accounts. Sometimes it takes careful consideration to know whether or not you really need a particular line item. Even if you have asked the two elegance questions and decided that this level of detail is absolutely necessary, you may be able to capture the information without adding additional line items.

For example, if your nonprofit pays directly for its own utilities, you will likely choose to have a utilities line item. However, would you need to include a line item in your chart of accounts for each different type of utility expense? If there is only one vendor to whom you make payments for electricity, most accounting systems offer the ability to run a report by vendor to isolate those expenses. Likewise, this would be true if there is only one vendor for water, or gas, or sewer, and so on. You must ask yourself if you really need to add a separate line for each one of these related expenses, or could you code them all to the same line item and, when necessary, capture the detail by running a report by vendor.

Using Account Groups or Roll Up Accounts for Better Reporting

Another way to ensure your chart of accounts is as elegant as possible is to use account groupings or roll up accounts to organize your line items. Creating account groups or summary accounts allows you to be intentional about what level of detail you share in your financial reports, which is useful when you present financial information to a variety of audiences. Guide each audience to ask the right questions of the information and to engage at the proper level of responsibility and strategy.

You may want your finance committee to view your financial reports in full detail, with all the individual line items displayed. Giving the finance committee a detailed report allows them to review line items with enough transparency to satisfy their compliance and oversight role. For your full board, you may prefer to present a set of financial reports that collapses (or rolls up) related line items so that a much smaller number of revenue and expense categories are displayed. A condensed financial report can better focus your board on strategic questions like how much you should keep in reserves or how much to invest in a campaign to increase individual contributions.

Let Your Chart of Accounts Reflect Your Business Model

Nonprofit business models are usually driven by just a few major income sources and a few major expense categories. You can learn a lot about your business model by simply totaling the three largest income line items and totaling the three largest expense line items. The percentage that each of these two sums represent compared to your nonprofit’s total revenue and total expenses is revealing – it can sometimes be as high as 70 or 80 percent. This exercise can help focus your attention on the large revenue and expense categories that effect your organization’s financial results the most. It is a good strategy to build your account structure and account groupings to capture and prominently display the most influential items. You can declutter your chart of accounts and your reports by limiting or, at least, rolling up the other accounts that have less influence on your business model.

In the revenue section of your chart of accounts, consider separating contributed support from earned revenue. Contributed support may include foundation grants, individual donations, bequests, and other types of gifts. Earned revenue may include contract fees, certain membership dues, client service fees, and other revenue paid for service. The organizational capacity required to attract and support each of these two types of income is different enough that it is useful to track and report them separately. The ratio of these two categories of income is another important descriptor of your business model.  

Use Your Chart of Accounts to Capture Full Program Costs

As we mentioned in the previous discussion of elegant cost centers, allocating administrative and fundraising costs to your program areas is a powerful tool in understanding and guiding your organization’s financial health. One way of allocating administrative and fundraising costs uses separate line items called administrative allocation and fundraising allocation. The administrative allocation line item is used to distribute a proportionate amount of the total administrative costs to each program area and to fundraising, usually based on an allocation method like percentage of FTEs or percentage of staff hours coded to each. After the administrative allocation, the fundraising allocation line item is used to distribute a proportionate share of the total fundraising costs to each program area, usually based on an allocation method like percentage of grant dollars raised.

The result after the distribution of administrative and fundraising expenses is a picture of the full costs for each program. Displaying full costs is an effective counter to the overhead myth that falsely claims  nonprofits are more effective when they keep their investment in core administrative and fundraising activities low. Knowing the full costs of each program allows for strategic fundraising, informs important discussions about program priorities, and illuminates whether any particular program or programs is subsidizing other programs.

Simple Can Be Sophisticated

Building an elegant chart of accounts requires balancing the need for sufficient relevant financial data with the desire to keep reports as simple and understandable as possible. When put together thoughtfully, a limited number of line items can convey financial information effectively. Complexity should not be confused with sophistication. A truly elegant chart of accounts, and the reports built from it, can express the financial story of a nonprofit fully and succinctly. 

Our next blog will provide practical examples of how to apply the principles above to building an elegant chart of accounts in Sage Intacct accounting software. Please subscribe to the blog to receive notice of our next posting. We regularly share on Elegant Financial Systems and other topics related to innovation in nonprofit finance.

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