A well-organized bookkeeping system is crucial for any business, and the backbone of this system is the Chart of Accounts (COA). 

The COA is a structured list of all the accounts your business uses to track its financial transactions, and it forms the foundation for preparing accurate financial statements. Think of it like the budget categories you use with your personal finances! 

Whether you’re just starting your business or looking to improve your current bookkeeping practices, creating a well-thought-out Chart of Accounts is essential. This guide will walk you through the steps to create one.

 

What is a Chart of Accounts?

The Chart of Accounts (COA) is a categorized listing of every financial account in your business’s general ledger. Each account is assigned a unique number to easily identify it in reports and analyses. That part is optional, but it can definitely be really useful for yourself and your accountant. 

The accounts are grouped into categories based on their role in your business’s financial system, such as assets, liabilities, equity, income, and expenses. If you use a numbering system, often the first digit corresponds with this account type. (Assets start with 1, liabilities start with 2, equity starts with 3, income starts with 4, and expenses start with 5+)

The COA helps you organize financial data, making it easier to prepare reports like income statements, balance sheets, and cash flow statements. It can tell you whatever you want it to, really! 

It’s a roadmap for tracking where your money is coming from and where it’s going, so you can make informed business decisions. This may be for your own peace of mind and understanding of your business, or to maximize tax write offs with your accountant. Or better yet, both! 

You may assess whether every part of your company is operating as efficiently as possible by looking at the COA. Maintaining consistency in your COA format throughout time will make it simpler to compare findings across data from multiple years. You may find that some accounts are too vague, and not giving you enough information. Or, some expenses may be really similar, and you want to group them together in your reports to make the reports easier to follow and understand. 

This serves as a financial health report for the company that is helpful to shareholders and investors in addition to the business owner. And it should be unique and custom to YOUR business. 

 

How does the Chart of Accounts Work?

In the order they appear on your financial statements, balance sheet accounts such as assets, liabilities, and shareholder equity are displayed first, followed by income statement accounts such as revenue and expenses. 

Depending on your particular requirements, you might also want to divide your company’s COA by product line, division, or business function. You may have multiple locations, or want to track the profitability of certain promotions, items, or services. 

 

6 Steps to Create a Chart of Accounts

1. Understand the Basic Categories

To get started, it’s important to understand the five primary account categories:

• Assets: These are resources owned by the business, like cash, inventory, accounts receivable, and property. 
• Liabilities: These are obligations owed by the business, such as loans, accounts payable, and accrued expenses.
• Equity: This represents the owner’s stake in the business, including retained earnings and common stock. Essentially, it is what is left over when you subtract total liabilities from total assets. 
• Income/Revenue: Accounts that track money earned from business activities, such as product sales or services rendered. It’s important to note that not all cash into your business is necessarily income/revenue. Consult your bookkeeper or accountant for more information on this! (Example, an owner investing their own cash into the business is usually NOT income.)
• Expenses: These accounts capture the costs incurred in operating the business, including rent, utilities, salaries, and marketing costs. There are many different expenses you have, and usually this is the area of your COA with the most accounts. 

Each of these categories will have sub-accounts that go into further detail, but understanding these basic groups will help you structure your COA properly.

2. Choose an Account Numbering System

A good Chart of Accounts is logically organized with a clear numbering system. Each category is assigned a block of numbers, and within each category, sub-accounts are numbered in sequence. For example:

• 1000–1999 for Assets
• 2000–2999 for Liabilities
• 3000–3999 for Equity
• 4000–4999 for Income
• 5000–5999 for Expenses

Within these blocks, sub-accounts are given specific numbers. For example, under the “Assets” category, you might have:

• 1001 Cash
• 1002 Accounts Receivable
• 1010 Inventory

This numbering system keeps your accounts organized and easy to navigate. You can use account numbers with more or less digits, but usually 4-5 digits is recommended. 

One advantage to using a numbering system is that your financial statements will not be subject to alphabetical order, by default. Using a number system will allow you to order your accounts in whatever way you like. 

3. Identify Your Business’s Specific Needs

Every business is unique, and your Chart of Accounts should reflect your business’s specific financial transactions. Identify what types of transactions are most common for your company and tailor your COA to match.

For instance, a retail store might need specific asset accounts for “Inventory” and liability accounts for “Accounts Payable to Suppliers.” A service-based business, on the other hand, might focus more on labor-related expense accounts like “Contractor Payments” or “Software Subscriptions.”

Start with general categories and refine them based on your business model. Some common sub-accounts might include:

• Assets: Cash, Accounts Receivable, Inventory, Prepaid Expenses, Property, and Equipment
• Liabilities: Accounts Payable, Credit Card Payable, Loans Payable, Accrued Liabilities
• Income: Sales Revenue, Service Income, Product Income, Other Income
• Expenses: Rent, Salaries, Utilities, Office Supplies, Marketing Expenses

4. Keep It Simple, But Detailed Enough

Your COA should be detailed enough to give you a clear picture of your financial situation, but not so complicated that it becomes difficult to manage. 

A common mistake businesses’ make is overcomplicating their Chart of Accounts by adding too many sub-accounts.

A good rule of thumb is to create sub-accounts only if they provide useful information for decision-making. For example, instead of breaking down every utility into its own sub-account, group them under a general “Utilities” expense account unless you specifically need to track them separately.

5. Use Accounting Software

Most accounting software programs, like QuickBooks, Xero, or FreshBooks, allow you to set up and manage your Chart of Accounts easily. These platforms often come with a default COA template that can be customized to fit your business.

When setting up your accounts in the software, pay close attention to the way you categorize transactions. Properly setting up your COA ensures that your financial reports will be accurate and easy to understand.

6. Review and Adjust Periodically

Your Chart of Accounts is not a static document. As your business grows and evolves, so should your COA. Periodically review your accounts to ensure they are still relevant to your current operations. You may need to add, remove, or merge accounts as your business processes change.

For example, if you start selling a new product or service, you might want to create a new income account to track its revenue. Similarly, as your business expands, you may incur new types of expenses that require additional sub-accounts.

 

Best Practices for Your Chart of Accounts

• Consistency: Once you establish your COA, stick to it. Consistency in using the same account for similar transactions ensures more accurate reporting over time.
• Use Descriptive Names: Account names should clearly describe their purpose. This helps anyone who reviews your financials, such as accountants or auditors, understand what each account represents.
• Avoid Redundancy: Don’t create multiple accounts for the same type of transaction. For example, instead of having separate accounts for “Office Supplies” and “General Supplies,” consider merging them under a single “Supplies” account.

 

Organize Your Financials with Glo-ing Profit

Creating a Chart of Accounts for your bookkeeping system is an essential step in organizing your finances. 

Remember that you need to understand your business’s financial needs, set up a logical numbering system, and use accounting software to build a COA that supports accurate reporting and informed decision-making.

Don’t forget to regularly review and adjust your COA to ensure it stays aligned with your business as it grows, helping you maintain control over your finances.

A well-structured Chart of Accounts simplifies bookkeeping, streamlines financial reporting, and gives you a clear view of your business’s financial health, allowing you to focus on growing and managing your business effectively.

But if you still find it challenging to take care of your financials, Glo-ing Profit can help you with that!