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What is the chart of accounts?
A chart of accounts is a list of accounts available for recording transactions in a company’s general ledger. Think of it as the filing cabinet for your small business’s accounting system. It’s used to organize transactions into groups. This helps keep track of money coming in and out of the company, especially when it’s time to file taxes.
Most QuickBooks Online plans, for example, support up to 250 accounts. The average small business shouldn't have to exceed this limit if it sets up its accounts efficiently. For example, if you buy a ladder for your roofing company, you can put it in the "equipment" account under assets, instead of dedicating an entire account to "ladders."
Typical charts of accounts have five primary accounts: assets, liabilities, equity, expenses and revenue. These accounts are used to generate balance sheets and income statements:
Income statement = Expense + Revenue accounts.
Balance sheet = Assets + Liabilities + Equity accounts.
Expense and revenue accounts make up the income statement, which provides insight into a business’s overall profitability. The remaining three accounts make up the balance sheet, which conveys the business’s financial health at that point in time and whether it owes money.
How a chart of accounts works
Each time you log something in the chart of accounts, you’ll make two entries: a debit from one account and a credit to another. For example, if you own a local grocery store and sell $20 in fresh produce, you'd debit the cash account $20 and credit the revenue account $20. This is known as double-entry accounting, and the sum of the two entries should be zero each time. Traditionally, credits always go on the right side of the chart and debits on the left. If you can’t decide whether something should be credited or debited, remember this: Expenses and assets increase when debited, while liabilities, equity and revenue decrease when debited.
Accounting software can simplify the process and minimize manual data entry. Popular products, such as QuickBooks Online or Xero, will balance out your credits and debits for you, and set you up with a standard chart of accounts that has categories relevant to your industry.
Each line on a typical chart of accounts will include an account number, title, description and balance. Traditionally, accountants can tell which account a transaction belongs to based on the first digit of the account number; for example, assets accounts are generally numbered 100 to 199 and liabilities are generally numbered 200 to 299. This helps keep books organized.
The accounts used to generate the balance sheet come first, followed by the accounts used to generate the income statement accounts. Some businesses also create categories based on department: One for sales, one for accounting, etc. Within each department, there may be subcategory expense accounts for wages, utilities and more.
Assets: any resource your company owns that provides value.
Liabilities: any debt your company owes.
Equity: what’s left after subtracting your company's liabilities from its assets.
Revenue: the money your business brings in from the sale of its goods or services.
Expenses: all the types of money and resources your business spends in an effort to generate revenue. To calculate net income, subtract expenses from revenue.
Chart of accounts examples
Example 1 The ladder you bought for your roofing company was $300. You’d credit $300 to the business’s bank account (which falls under cash assets) and debit $300 to the equipment account (which falls under fixed assets). Money is flowing out of your business, and in exchange, you're gaining new equipment.
Example 2 Let’s say you’re paying rent in cash. In that case, you’d credit the cash asset account, since cash is leaving your business, and debit your expense account for rent. Alternatively, if you’re using accounting software, it’ll know which accounts to credit and debit.
Example 3 You receive a $15,000 small-business loan and you’re using QuickBooks Online. You click the plus-sign icon in the upper right corner and select Bank Deposit.
After that, you fill in information about the transaction and label it “Small Business Loan,” which is nested under “Long Term Liabilities.” In this case, the liabilities account already exists in your books, and the software product autofills its name for you. If you needed to create a new account for the loan, you’d click Add.
Once you finish filling in the information, you see a new transaction in your chart of accounts for a $15,000 small-business loan. Your checking account is automatically updated and $15,000 is added to the balance. In this case, you credited $15,000 to your loan account (liabilities), and QuickBooks Online debited $15,000 to your checking account (assets) to balance it out.
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 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 gives you important information. That doesn’t mean recording 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. 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 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's an opportunity for consolidation. This will make handling your accounts more manageable.
Stacy Kildal, a former Fundera writer, contributed to this article.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.