The Right General Ledger – Revenue

I want to focus on the last two, Revenue and Expense, and decisions you must make about detail GL accounts in order to build a proper business story.

 Organizing Revenue Accounts

The way you organize income should be based on what type of business you run and the specific revenue stories you want to track.

In a typical “default” chart of accounts, you will find the following types of revenue (most will be labeled “Income”) accounts:

• Sales of Products Income
• Service/Fee Income
• Discounts/Refunds Given
• Other Income

That doesn’t mean you can only record revenue in four GL accounts. You can record revenue in as many GL accounts as you like, but the revenue would be classified as one of the above types of income. You also do NOT have to create GL accounts for all four types. So, which do you use, and how many?

First question, what do you sell? Do you sell products or do you sell services? Or do you sell both? Do you give discounts? Do you charge for shipping and want to separate that from the actual product revenue? Do you give refunds?

Let’s start with an example of a company that just sells products, charges an additional fee for shipping, does give discounts, and does offer and give refunds when needed.

You could set up your GL accounts as:

You would record all product sales into the Sales – Products GL account and all shipping charges into the Sales – Shipping account. Why separate shipping? If you include shipping into the same account as sales, you are distorting your story. You want to be able to read a story that accurately tells you the sales trends and totals of your actual products. The shipping is variable based on location, postage or freight charges, and could potentially mask the real story of sales.

What about the discounts and refunds? Good question. If you use only the accounts listed above, then any discounts given and/or refunds are going to be recorded in the Sales – Products account and you are not accurately capturing that part of your story. So, here is another GL account strategy to consider:

 You can now record any discounts and refunds into specific GL accounts.

Tracking Sales Discounts

As a business owner, one of these may be an important storyline to track. If your pricing is ALWAYS discounted and you control that discount at all times (meaning, your real price is just the discounted price anyway), then you probably do not want to go to the trouble of tracking the discounts.

However, if you employ sales personnel that have latitude in giving discounts, either an optional standard discount or some range of possible discount, this account will be very important in reading the ongoing story of your business.

For example, let’s say that you track the trend of this Sales – Discount as a percentage against the Sales – Products line. You start noticing that over the past three months that the Sales – Discounts line is rising as a percentage against sales (e.g., was 1% of sales, then 2% sales, now 5% of sales). What story does this tell you as the CEO and/or business owner?

This type of story tells you that either (a) the are some market conditions that are creating a true need for additional discounting (e.g., new competitor, slower demand, economic condition) or (b) something is not right with the sales team (e.g., new sales person that just goes straight to discount to win, current sales person losing edge, a new product is in the mix that they do not know how to sell). You can proactively see this storyline developing and make some immediate decisions where required.

Tracking Refunds

You probably are already picking up on the theme here. If you offer refunds where required (e.g., defective product, not what expected, etc.) and you do NOT track these refunds in a separate GL account, you may miss an important storyline in your business.

If refunds increase and it is buried in your one Sales – Products line, you will just see a storyline that shows an inaccurate product sales total trend (since refunds are distorting those totals). It may take a lot of inquiry and analysis before someone realizes that the culprit is a rise in refunds.

At the same time, if you separate refunds into a separate GL account as above, you can quickly see when refunds increase and immediately start asking direct questions to find out why this is happening.

So How Specific Should You Get for Revenue Accounts

The final question on Revenue accounts to answer is how specific should you get in terms of revenue GL accounts.

My suggestion in terms of building the right story to follow would be these guidelines:

1. If you sell products and these products are basically all the same type of product – same sources, same typical margins, same sales channel, etc. – then one Sales – Product Income account should be sufficient.
2. If you sell products but these are distinctly different in source, sales channel, or just something that you truly want to use GL sub-accounts to track separately, like:

GL Account: Sales – Product Income

GL Sub-Account: Sales – Product 1 Income

GL Sub-Account: Sales – Product 2 Income

GL Sub-Account: Sales – Product 3 Income

When reporting, you can then choose to only see the parent account total (which will aggregate at the GL account level, or you can also include the sub-accounts on the report to track separately as a storyline. This gives you the ability to see the storyline of each product.

3. If you sell services, then you should have a Sales – Service Income GL account to record service sales. This will become very significant during our discussion of COGS (Cost of Goods Sold – Cost of Services) and the Gross Margin storyline. Mixing product and service sales into one revenue line will greatly limit your view of any revenue storylines.
4. If you sell more than one type of service and you want to see those storylines separately (they are unique types of services with different margin potentials), then use the method described in (2) above to create sub-accounts for services.
5. Discounts and Refunds were already discussed above and should typically be included if they are frequent enough and/or substantial enough to impact your story.

Example Revenue GL Accounts

Below is a sample of GL accounts from a Software Sales and Services business. This business has the following types of incomes:

• Re-sells three specific software packages from two suppliers.
• Sells the software maintenance contracts that entitles customers to upgrades and fixes
• Training Services
• Contract programming/consulting services

 Using these GL accounts and properly recording transactions into the correct accounts, this CEO/business owner can access views and reports to track the following different storylines:

• The storyline of overall revenue growth (all accounts will summarize into the INCOME (Revenue) total on any Profit & Loss reports or other reporting of income.
• The storyline of Software Sales (can see the specific total for Sales – Software Sales)
• The storyline of any of the three software packages (Package 1, Package 2, Package 3) to track those sales specifically.
• The software discount
• The services income This would assume that both types of services mentioned were roughly the same margin and there was no need to track separately (more about Margins in the next post).
• The maintenance sales This is important since the maintenance revenue in software companies is recurring revenue and very high margin compared to the initial sale of the software.

Too late to Change?

One question that probably came to mind while reading this is “is it too late to change my GL chart of accounts?” No, it is not too late. However, for existing businesses with historical financial records (whether a few months or years), please consult an experienced accounting professional (e.g., CPA) to make these changes. The reason I recommend that is that you would likely want to re-categorize some or perhaps a lot of past transactions in order to ensure you can examine trends that are correct. You can do this, but must ensure the integrity of past financial tax reporting.

I also recommend that you read the next post in this series – which focuses on the Expense portion of the GL chart of accounts – before making any final decisions.

We’ve covered revenue in the chart of accounts and in the next post we will finish the general ledger discussion with a focus on Expenses (Cost of Goods Sold/Cost of Services and General & Administrative) then move on to discuss fundamental Profit & Loss terminology like Gross Margins, Ordinary Income, Operating Income, EBITDA, Net Earnings, Regular Earnings, and a number of terms you may have heard kicked around in meetings, presentations, and accounting meetings.