No matter what type of business you operate, you need a chart of accounts. It's the basis of a good small business accounting system and functions as a map of your business’s finances. Your chart of accounts is the listing of the accounts that are currently made available for recording transactions in your general ledger, along with the account type, account balance and a brief description.
Bigger and more complex companies can have hundreds, even thousands of accounts. Small businesses typically have fewer accounts. The types of accounts you have also reveal the nature of your business. If you operate a restaurant you will probably have more references to food products in your chart of accounts.
Every time you record a business transaction — be it taking out a loan, purchasing supplies or processing an invoice — you must record it in your chart of accounts. Armed with one, you’ll have a better understanding of your business’s financial outlook, have an easier time following financial reporting standards and be able to make smarter business decisions.
Types of accounts
A chart of accounts shows each account a company owns in the order it appears on the company’s financial statements. That means balance sheet accounts are listed first, followed by income statement accounts. Typically, each chart in the list is assigned a multi-digit number for identification purposes. Note that in QuickBooks Online, you can’t order your chart of accounts in any way other than alphabetical.
Let’s take a look at the types of accounts that fall under balance sheets and income statements.
There are three different types of balance sheet accounts:
Asset accounts record any resource your company owns that provides value. Examples of asset accounts include things like inventory, real estate, equipment and accounts receivable.
Liability accounts are a reflection of all the debt your company owes. They include things like accounts payable, taxes payable and wages payable.
Equity accounts are a measurement of how valuable a company is to its shareholders. It’s essentially what’s left when you subtract a company's liabilities from its assets. Examples include common stock, preferred stock and retained earnings.
Here are the major kinds of income statements:
These accounts are a reflection of the revenue your business brings in from the sale of goods, services or rent.
These accounts show all the money and resources your business expends in an effort to generate revenue.
If revenue increases, this will increase your business’s asset and equity accounts. On the flip side, if expenses increase, this will decrease your business’s asset and equity accounts. Within your income and expense accounts, many businesses create sub-accounts based on the business function of company division. For example, some businesses may organize expense accounts by department: One for sales, one for accounting, etc. Within each department, there will be expense accounts for wages, utilities and more.
For every business transaction, at least two accounts are involved in the double-entry accounting method: One is debited and one is credited. If you use QuickBooks Online and you go to input a transaction, the software will know to debit one account and credit another. For example, if you are paying rent in cash, QuickBooks will credit your cash asset account and debit the expense account for rent.
To help you best manage your chart of accounts, here are some things to keep in mind:
Wait to delete old accounts: In the interest of not messing up your books, it’s best to wait until the end of the year to delete old accounts. Merging or renaming accounts can also create headaches come tax season. However, you can add new accounts at any time.
Don’t go overboard with your accounts: Create a chart of accounts that will give you important information, but that doesn’t mean every single detail about every single transaction. You don’t need a separate account for every product you sell, and you don’t need a separate account for each utility. Certain items can be lumped together.
Aim for consistency: You should strive to create a chart of accounts that doesn’t change much year over year. This way you can compare the performance of different accounts over time, providing you valuable insight into how you are managing your business’s finances.
Prune your accounts: At the end of the year, review all of your accounts and see if there is an opportunity for consolidation. This will make handling your accounts more manageable
Making the most of your chart of accounts
It can seem overwhelming to manage your chart of accounts, but accounting software can carry most of the burden. The QuickBooks Online default chart of accounts is usually sufficient for most small businesses.
If the setup it provides doesn’t work for you, take the time to find an advisor to help you create a chart of accounts that will give you the information you need to make decisions about your business and your future. Staying on top of your chart of accounts will give you an accurate snapshot of your business’s financial outlook and provide you with peace of mind whenever it comes time to make an important business decision.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.