What Is a Chart of Accounts? A Small Business Bookkeeping Guide
A chart of accounts is a small business accounting tool to organize the important accounts that help create your business’s financial statements. Your chart of accounts is a useful document that lets you present all the financial information about your business in one place, giving you a clear picture of your company’s financial health. The chart of accounts organizes your finances into five major categories, called accounts: assets, liabilities, equity, revenue and expenses.
These topics will help you better understand what a chart of accounts is and how its used by small businesses:
What Is a Chart of Accounts Used For?
Small businesses use the chart of accounts to organize all the complex details of their company finances into an accessible format. It’s the first step you’ll take to set up your business’s accounting system. The chart of accounts clearly separates your earnings, expenditures, assets and liabilities to give an accurate overview of how your business is performing financially.
The chart of accounts organizes your finances into numbered account categories. Most businesses follow this consistent, commonly accepted account numbering system:
- 1000 – 1900: Assets
- 2000 – 2900: Liabilities
- 3000 – 3900: Equity
- 4000 – 4900: Revenue
- 5000 – 5900: Expenses
Although it’s not necessary that you follow that format, businesses generally follow the same numbering system for the chart of accounts because it makes it easier for an accountant or bookkeeper to step in and translate the information into standard financial reports. If you’ve worked on a general ledger before, you’ll notice the accounts for the ledger are the same as the ones found in a chart of accounts.
What Are the Five Major Accounts?
The five major accounts provide the structure for your chart of accounts, breaking it down into separate categories of information. Several important financial reports are built around the same five categories. The five major accounts you’ll use to create your chart of accounts are:
- Assets: Assets are resources owned by your business that can be converted into cash and therefore have monetary value. Examples of assets include your accounts receivable, vehicles, property and equipment.
- Liabilities: Liabilities are debts that your company owes to someone else. This would include your accounts payable and any taxes you owe the government.
- Equity: The role of equity differs in the chart of accounts based on whether your business is set up as a sole proprietorship, LLC or corporation. But the basic equation for determining equity is a company’s assets minus its debts.
- Revenue: Revenue is the amount of money your business brings in by selling its products or services to clients.
- Expenses: Expenses refer to the costs you incur in the process of running your business. This would include your office rent, utilities and office supplies.
Why Is a Chart of Accounts Important?
The chart of accounts allows you to organize your business’s complicated financial data and distill it into clear, logical categories. It also lays the foundation for all your business’s important financial reports. A chart of accounts is more than just an organizational tool, though. Having all your financial data in one place and seeing how the different accounts relate to one another can provide important insights into your business’s performance. Here are some ways a chart of accounts can benefit your business:
1. Understand Your Earnings
A chart of accounts gives you great insight into your business’s revenue. It doesn’t just tell you how much money you earn, it shows peaks and valleys in your income, how much cash flow is at your disposal and how long it should last you given your average monthly business expenses.
2. Get a Grip on Debts
A chart of accounts gives you a clear picture of how much money you owe, both in terms of short- and long-term debts. Your chart of accounts can help you determine how much of your monthly income you can afford to put toward your debts and help you develop longer-term debt repayment plans.
3. Spend Smarter
It’s not always fun seeing a straightforward list of everything you spend your hard-earned money on, but the chart of accounts can give you an important view of your spending habits. You can get a handle on your necessary recurring expenses, like rent, utilities and internet. You can also examine your other expenses and see where you may be able to cut down on costs, if needed.
4. Improve Your Reporting
A chart of accounts organizes your finances into a streamlined system of numbered accounts. Having an accurate chart of accounts makes it easier for you or an accounting professional to develop in-depth financial reports to help you understand the financial position of your company, including a cash flow statement, balance sheet and income statement.
5. File Taxes
An added bonus of having a properly organized chart of accounts is that it simplifies tax season. The chart of accounts tracks your business income and expenses, which you’ll need to report on your income tax return every year.