Xero In On Xero; Tracking Categories

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A well-structured chart of accounts is crucial to clear annual financials to be used for compliance needs.  But to make the move into management accounting and advisory services, more insight is needed into all the component parts of a business.  Enter the concept of Tracking Categories. Today we are going to give an introduction to using tracking categories, along with some examples of how they can be deployed and what the potential benefits are.

We should emphasize that, along with the chart of accounts and the rest of the accounting framework, it’s important to think about the end reporting at the beginning.  Ask the end-users of company financial data what they need to know in order to make strategic decisions effectively and then measure the results.

So what are Tracking Categories?  Essentially built as a “tagging” mechanism for transactional data, they allow additional classifications beyond just the account name/account code. This allows not just a one-dimensional (single column in a spreadsheet) or even two-dimensional (spreadsheet rows and columns) data array, to a full three-dimensional data array. Think of moving from one face of a Rubiks cube to the full cube - you can turn it to see different aspects of the data set, or even twist and turn it to see different combinations.

So how should they be set up to maximize the value?  Use them in areas where both revenue AND related expenses should be tracked.  If it’s only a revenue area, it’s still appropriate to use multiple accounts. 

Also, it’s important to note that Tracking Categories should be used with broad enough options that they will see repeated use over time.  For one-time uses, such as job costing, Xero Projects or an add-on solution will be more appropriate.  Currently, there is a soft cap of 100 options for each Tracking Category, although in practice anything more than 15-20 quickly becomes unwieldy.

A few examples of how Tracking Categories can be utilized are listed below:

  • Real Estate - Property Type/Agent
  • Dev Company - Contract Type (Retainer, Hourly, etc)/Product Type (App, Website, etc)
  • Consumer Product - Product Line/Geographical Region
  • Not-For-Profit - Program Areas/Grants & Restricted Assets (read next week’s Xero In On to learn more)

To help visualize the value of these in advisory services, the following is a quick dive in the financials of a fictitious professional services company.  On the surface, it looks like a solid company, with nothing needed other than to keep on the same course - good margins, and profit levels are consistent with industry benchmarks.

But after using the first Tracking Category to split the financial results into East and West Divisions, we find some interesting trends:

Even though the East Division has only half the revenues, it’s still producing the same effect to the bottom line as the West Division, which consumes a much higher level of organizational resources for the same results.  It would appear that shifting sales efforts to focus on East would provide the fastest track to higher profitability.  But let’s look one level deeper, using the second Tracking Category:

When this final piece is factored in, it’s clear that significant changes need to make to the Apps component of the business model, at least in the West Division.  As this company’s advisor, you can now help them craft an actionable business plan based around solid data.

In conclusion, Tracking Categories provide the backbone for an efficient accounting framework with the potential for deep advisory insights.  You can use them on your journey towards being a Connected Advisor, and reap the benefits.

XPT:  Tracking Categories sort alphabetically by default - start the option name with a number if you want to see them in a particular order.  Example: 10-Sales, 20-Operations, 30-R&D, etc.  Place higher volume categories towards the top of the list, so that you spend less time looking for an option in a drop-down menu.

Dan Schmidt is the CEO of The Emerging Business CFO, a virtual accounting and financial advisory firm that works to free founders and entrepreneurs from the stress of managing the daily operational grind. The company offers operational accounting, systems setup and fractional CFO services. Twitter: @ebcfo