How to Set Up a Chart of Accounts for a Small Business

The chart of accounts is the list of every account your books can post to. Every report is built from it: the profit and loss, the balance sheet, the tax summary your accountant prepares. A messy chart produces messy reports, and fixing it after a year of transactions is slow. A clean one takes an afternoon to set up. This guide covers the structure, the numbering, how much detail to keep and the mistakes to avoid. It is general information, and your CPA has the final word on how accounts should map to your tax return.

The five types of account

Every account belongs to one of five groups. Knowing them tells you where a new account goes.

• Assets are what the business owns or is owed: bank accounts, receivables, equipment, inventory.
• Liabilities are what it owes: credit cards, loans, payables, payroll and sales tax collected but not yet paid.
• Equity is the owner’s stake: what was put in, what was taken out and what has been retained.
• Revenue is what the business earns from its work.
• Expenses are what it spends to operate. Many charts keep what you spend directly on the goods you sell (cost of goods sold) apart from the other operating costs.

Assets, liabilities and equity appear on the balance sheet. Revenue and expenses appear on the profit and loss.

Numbering that makes sense on sight

Numbers are optional in much software, but they keep accounts in a stable order and make a report easy to scan. A common convention uses blocks:

• 1000s for assets
• 2000s for liabilities
• 3000s for equity
• 4000s for revenue
• 5000s for cost of goods sold
• 6000s and up for operating expenses

Leave gaps. If you number accounts 6010, 6020 and 6030, you can add 6015 later without reshuffling. Keep related accounts together, so rent, utilities and insurance sit near each other.

Start from a template, then trim

Most accounting software offers a starter chart for your industry. Begin there, then go through it line by line.

1. Delete the accounts you know you will never use.
2. Rename the ones whose labels do not match how you talk about the business.
3. Add the accounts you need that are missing, such as a separate revenue line for each main product or service.
4. Look at the bank and card accounts you have and make sure each one has its own account in the chart.

Do this before you enter many transactions. Changes are easier when there is little history behind them.

Deciding how much detail

The test for a new account is whether you would ever read a report that depends on it. If you would, make it. If you only might, do not.

Too few accounts and everything lands in “supplies” or “other”. Too many and transactions are hard to categorize and the same cost ends up in three places, which makes reports harder to trust. A few habits keep this in check:

• Use sub-accounts for the cases where you want both a total and a breakdown, such as advertising split into online and print.
• Track a product line, a location or a client with the software’s tags, classes or projects, if it has them, instead of creating an account for each.
• Keep the accounts your accountant needs for the tax return, and ask which ones those are.

Naming accounts

Name an account for what it holds, in the words you would use out loud. “Software subscriptions” is better than “Misc 2”. Keep the style consistent: if one account is “Office supplies”, do not name its neighbor “Postage & Shipping Costs (all)”. Avoid account names that describe a person or a single vendor, since the vendor will change and the account will not.

Handling the owner’s money

How owner activity is recorded depends on your business structure, and getting it wrong can distort both the balance sheet and the taxes. A sole proprietor, a partnership and a corporation treat money taken out in different ways. Ask your CPA how draws, distributions, contributions and any loans between you and the business should be set up, and keep them out of the expense accounts. Do not pay personal costs from the business account and expect to sort them out later.

Accounts that should stay empty

Some accounts exist to catch things temporarily:

• Uncategorized income or expense.
• Undeposited funds, where customer payments wait until the bank deposit is made.
• Any suspense or ask-my-accountant account.

None of them should hold a balance for long. At each month end, clear them as part of the close checklist. A permanent balance in a clearing account is a sign that something has not been put where it belongs.

Review it once a year

A chart of accounts is not fixed. Set a time each year, ideally just before year end, to look for accounts that were never used, accounts that are overloaded and accounts your accountant asked for that you do not have yet. Make changes at the start of a period, back up first and tell your accountant what you changed.

Common mistakes

• Copying another business’s chart without checking it fits.
• Creating a new account for every vendor.
• Mixing personal and business transactions in the same account.
• Leaving a suspense account to grow.
• Renaming or deleting accounts mid-year without a note, which makes comparisons across months unreliable.

If you are unsure which parts of this you should do yourself and which to hand over, the bookkeeper or accountant page sets it out. Terms used here are defined on the accounting terms page, and the bookkeeping section has more on day-to-day categorizing.