Staying on top of your finances as a small business can be challenging. But it’s an important practice if you want to understand and improve your cash flow.
A chart of accounts helps you keep track of your transactions by breaking them down into five main categories. Here’s everything you need to know about charts of accounts, from how they work to getting started with them.
What is a chart of accounts?
A chart of accounts is an index of financial transactions your company has made during a certain time frame—usually a dedicated accounting period. Each transaction is organized by category to provide a clear breakdown of what was earned and spent.
Explanation of chart of accounts
Your chart of accounts is a financial roadmap for your business. It’s a filing system where you can see all of your transactions in one place, each stored under a relevant term. Most charts of accounts cover assets, liabilities, equity, income, and expenses to give you a full picture of your business’s financial health.
The importance of a chart of accounts for small businesses
A chart of accounts is important for four main reasons:
- Business overview: It gives you a clear view into how the different parts of your business are performing financially and the company’s overall financial health.
- Reassure shareholders: It gives shareholders peace of mind and provides potential investors with detailed insights into your company’s financials.
- Better decision-making: It provides a foundation for making informed financial decisions, such as new investments, hiring, and product development.
- Stay compliant: It’s an easy way to ensure you’re following the latest financial reporting standards.
Chart of accounts basics
Keeping your books in order is an important part of running a business. If it isn’t your strong suit, that’s OK. Setting up your chart of accounts is a step toward a clear financial view of your business.
How does it work?
One of the main functions of a chart of accounts is to facilitate double-entry accounting, a record-keeping system that documents each business transaction twice. One entry shows the source of money, the other entry shows the money’s destination.
The double-entry system displays two columns for these entries, called debits and credits. This allows you to track money coming into your business and money going out of it.
Double-entry allows you to create other accounts to track money not yet received (accounts receivable) or paid (accounts payable), and goods held for sale (inventory). This is where a chart of accounts is needed to organize and track the details of each transaction.
In a chart of accounts, your accounts are shown in the same order they appear on your financial statements and are usually broken down into five main categories.
Balance sheet accounts:
- Shareholder equity
Income statement accounts:
You can structure your chart of accounts in a way that best suits you. For example, you can categorize your revenue and expenses depending on what you sell, who you sell to, and what level of business you’re at.
Chart of accounts list of account types
A standard chart of accounts contains multiple accounts under each category. Your company might have an account for cash on hand, a separate one for accounts receivable, and a third for real estate holdings, all three of which are categorized as asset accounts. Here’s how accounts are typically categorized.
Balance sheet accounts
Asset, liability, and equity accounts are listed on a company’s balance sheet, a statement that shows a company’s financial position at a given point in time. Here’s an overview of what might be included in each of your company’s balance sheet accounts.
- Asset accounts. Cash, securities, accounts receivable (AR), and inventory are all asset accounts.
- Liability accounts. Accounts payable, taxes payable, wages payable, and accrued liabilities are classified as liability accounts.
- Equity accounts. Common stock, retained stock, dividends, retained earnings, and owner capital are all examples of equity accounts.
Income statement accounts
Income statement accounts include expense and revenue accounts. The income statement (or profit and loss statement) shows a company’s performance over a reporting period. These accounts track how much money has been gained or lost during the period of time in question.
- Expense accounts. These include categories such as the cost of goods sold, operating expenses, non-operating expenses, credit card expense accounts, and prepaid expense accounts.
- Revenue accounts. Revenue accounts include sales revenue, dividend revenue, and gains on the sale of an asset, as well as any other revenue sources your business claims, such as rent or royalty income.
The basic chart of account categories
Each account type is broken down into multiple categories. For example, your balance sheet accounts might be split into the following subcategories:
- Accounts receivable
- Prepaid expenses
- Fixed assets
- Petty cash
- Wages payable
- Accrued liabilities
- Preferred stock
- Retained earnings
- Common stock
Chart of accounts organization
How is a chart of accounts organized?
Every account on your chart of accounts will include the following three things:
- Identification code
This will help you locate specific accounts and transactions, especially when you’ve been operating for a while and your ledger starts to get more complex.
Chart of accounts numbering
The way your accounts are numbered will help you stay on top of your finances and easily find transactions in each subcategory.
The most common way to number your accounts is with a parent-child structure. This usually follows a four-digit numbering system that can then be broken down into smaller, similarly numbered additions.
For example, you might number you accounts using a system like this:
- 1000 for your current assets accounts, cash accounts, and accounts receivable
- 2000 for liabilities, including accounts payable and accrued expenses
- 3000 for owners’’ equity accounts, including common stock and investments
You can then nest similar accounts under broader categories within each of these ranges.
Note that the more accounts you add, the more likely you are to run out of numbers in each of the parent categories, and it can be difficult to go back and slot new numbers in.
Example of a chart of accounts
Here’s an example of what a chart of accounts might look like with a numbering system in place.
Chart of accounts best practices
Maintaining an organized, user-friendly chart of accounts is important for operating a double-entry accounting system. It makes it easy for your accountant or adviser to see the financial health of your business and access key business insights, and can save time if you are audited.
Following a few key best practices can help set you up for success.
Be consistent in naming accounts, subcategories, and labeling
Establishing and following a naming system for your chart of accounts can help you identify the purposes of each account and prevent confusion across account types.
Using accounting software can simplify this by encouraging you to file individual accounts by account type. You might, for example, have an account labeled “Credit card operating expenses” filed under liabilities.
Accounting software platforms include a sample chart of accounts or a template demonstrating how accounts can be categorized and labeled. Following a template can take the guesswork out of creating a naming system and make it easy to share your books with an accountant or a financial adviser.
Consolidate accounts where possible
One of the benefits of accounting software is it allows you to have as many accounts as you need to see the way money is moving through your business.
This freedom, however, requires sound judgment. Just because you can have separate accounts for office supplies (analog), office supplies (digital), office supplies (snacks), and office supplies (drinks) doesn’t mean you should. This level of detail is unlikely to provide you with useful information, and it increases the odds you will enter a transaction in the wrong place.
How should you adjust your chart of accounts? It’s a good rule of thumb to look at your system at the end of every fiscal year and ask yourself whether any accounts can be consolidated or removed.
Wait until the end of the fiscal year to delete old accounts
If you’ve identified redundant or archaic accounts, it can be tempting to clean it up by deleting or by merging them. Resist this urge—at least temporarily. Waiting until the end of the fiscal year to delete, rename, or merge existing accounts will simplify your tax filing process, preventing you from losing or hiding relevant information from yourself over the course of the year.
Chart of accounts for small and medium businesses: A complete guide
The importance of a chart of accounts for small and medium businesses
Setting up and maintaining a chart of accounts might seem unnecessary if you’re just starting out. But the more organized you are now, the easier it will be when you start to grow.
Creating a chart of accounts not only shows a snapshot of your company’s financial health, it provides lenders and potential investors with all the information they need to know. This is crucial if you plan on applying for loans, investment, and funding when you expand.
How to set up a chart of accounts for a small or medium business
Before you start creating a number system and inputting different account types, you need to decide which categories apply to your company. As a small- or medium-size business, you won’t need as many as a large, enterprise business. It’s worth setting up as many as relevant so you don’t have to go back and do it later.
1. Set up your main account types
All charts of accounts use the same umbrella account types—you’ll want to do the same. Make sure you set up:
- Asset accounts
- Liability accounts
- Equity accounts
- Revenue accounts
- Expense accounts
2. Create your unique business accounts
Now, it’s time to break the umbrella accounts down into smaller subcategories relevant to your business. For example, small service-based businesses will often incorporate the following into their chart of accounts:
- Accounts receivable
- Accounts payable
- Income tax payable
- Cost of sales
When you’ve listed out your subcategories, organize them under the most relevant umbrella account. For example, accounts receivable will fall under your asset accounts.
3. Assign account numbers
Use the parent-child numbering system to assign account numbers to each of your accounts. This will help you find each account easily and create a well-organizing filing system.
COA and accounting software systems
The easiest way to manage your chart of accounts is to use an accounting software system that runs it on autopilot.
How to leverage a chart of accounts in accounting software systems
Most accounting software comes with a basic chart of accounts, making it easy to get started.
You’ll still need to customize it to meet your business needs. This includes entering the umbrella categories and your chosen subcategories. Once you’ve set it up you’ll be able to tag each transaction and file it under the relevant subcategory, easily.
It can be valuable to use accounting software to set up your chart of accounts right when you are starting your business. If you are changing software, it might take some time to set up and properly categorize your transactions. The process will vary depending on the accounting software you use, so take a look at tutorials and demos that can help you get set up quickly.
Best software to assist in setting up and utilizing a COA
Ready to get started on your chart of accounts? Here are some popular accounting tools to assist you in setting up and maintaining an organized chart of accounts.
- Freshbooks: Offers standard chart of accounts, with ability to customize under Plus, Premium, and Select accounts.
- Sage Intacct: Their CSV template allows you to import your existing chart of accounts.
- Xero: You can use one of their templates, which are pre-mapped to Xero’s report codes, or import your own.
- Intuit QuickBooks: It automatically sets up your chart of accounts for you, offering additional accounts based on your business type.
Chart of accounts conclusion
Regardless of how small your business is, a chart of accounts will help you stay on top of your company’s financial health. Start by setting up your main five accounts and deciding on which business accounts you want to fold in underneath them. Remember to regularly review to see if there are any missing data or entries that are no longer relevant or valid to your business.
- The importance of a chart of accounts: It provides a transparent overview of your company’s financial health and insight for potential investors.
- How it works: A chart of accounts records every transaction made in your business and organizes them under relevant categories.
- The different account types: A chart of accounts is broken down into five main account types, including asset accounts, liability accounts, equity accounts, revenue accounts, and expense accounts.
- Best practices: Consistently label your transactions and subcategories, consolidate your accounts where possible, and wait until the end of the fiscal year to delete old accounts.
- Get started: Set up your main accounts and then create your unique business categories. Finally, assign account numbers to each account type. Use accounting software to streamline the process.
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Chart of accounts FAQ
What are the 5 basic charts of accounts?
The five basic charts of accounts are assets, liabilities, equity, revenue, and expenses.
- Assets account for all the resources that a company owns and can use to generate income, such as cash, accounts receivable, inventory, and property.
- Liabilities include all the debts and obligations that a company owes, such as loans, accounts payable, and taxes.
- Equity reflects the amount of money that remains in the company after all liabilities have been paid. It includes the contributions made by the owners, such as capital stock and retained earnings.
- Revenue is the money that a company earns from its business activities, such as sales revenue, rental income, and interest earned.
- Expenses are the costs incurred by a company in running its business, such as salaries, rent, utilities, and supplies.
These five basic charts of accounts are the foundation for creating a more detailed and comprehensive chart of accounts specific to a company’’s business and industry. A well-designed chart of accounts is essential for accurate and meaningful financial reporting and analysis.
What is the chart of accounts a list of?
The chart of accounts is a comprehensive list of all the financial accounts used by a company to record and organize its financial transactions. It includes all the balance sheet and income statement items, such as assets, liabilities, equity, revenue, expenses, gains, and losses.
Each account in the chart of accounts is assigned a unique account number or code, making it easier to identify and track transactions. With a properly structured chart of accounts, a company can accurately capture financial data, generate financial reports, facilitate budgeting and planning, and ensure compliance with accounting and tax regulations.