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What is a Chart of Accounts & Why Does Your Business Need One? | Acuity

By December 1, 2023 No Comments

Managing finances can overwhelm even the most experienced entrepreneur. The good news is there’s a handy tool to give you greater financial clarity: say hello to a chart of accounts.

A chart of accounts – or COA for short – is a financial document that helps you categorize your transactions, simplifying your financial management and reporting.

A COA not only categorizes your transactions, but it lays the groundwork for two crucial financial statements: the balance sheet and income statement.

The balance sheet shows what your company owns and owes at any moment, and the income statement tracks your earnings and expenses over time. Pretty important stuff!

Keep on reading to learn what a chart of accounts includes and how to set one up that’s specific to your business.

What is a chart of accounts?

A chart of accounts is like an organized filing cabinet for your business’s bookkeeping, listing all accounts in the general ledger (the main accounting record of your company).

A COA categorizes each account by the type of financial information it contains.

This gives you a clear view of where your business earns and spends money! Not only does this help you make better business decisions, but it also makes it easier to follow financial reporting rules.

How is a chart of accounts structured?

1. Account type

A COA is organized into one of five main categories: asset accounts, liability accounts, equity accounts, revenue accounts, or expense accounts.

  • Assets include cash and inventory.

  • Liabilities are debts owed.

  • Equity is the owner’s value in the business.

  • Revenue is the money you receive for your goods/services.

  • Expenses are the costs incurred when running your company. (i.e. office supplies, utilities, rent, etc.)

2. Account numbers

Account numbers are a key part of a chart of accounts. Each account type is assigned a specific number that identifies its category and subcategory. The numbers often start with three or four digits – like 1000s for assets, 2000s for liabilities, 3000s for equity, 4000s for income, and 5000s for expenses.

From there, subcategories emerge to better organize your accounts. For example, within assets, cash could be 1001, accounts receivable could be 1002, inventory could be 1003, etc.

3. Account descriptions

On your COA, there should also be a place for a description of the account. This is where you can identify the subcategory, like accounts receivable or cash.

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How does a chart of accounts work?

Take a look at the chart of accounts example below. As you can see, assets are numbered from 1000 to 1009, liabilities from 2001 to 2014, and so on. This numbering system makes it easy to find the right spot for each transaction.

Using these set account numbers speeds up recording your business activities, helping you quickly see what each account is about.

Whenever there’s a new transaction, just add it to its matching account number. This way, you build a neat and organized financial history.

And the best part? You can use this info to easily put together important reports, like your income statement and balance sheet. You go!

standard coa

How to create a chart of accounts in 6 steps

Before logging any accounting records, you’ll want to develop a customized COA for your type of business. Here are the key steps to create a COA that can track various business functions and streamline your financial reporting:

  1. Do Some Research: Start by looking at examples of COAs used by businesses similar to yours. Note what types of accounts and sub-accounts you might need.

  2. Outline Your Structure: Sketch out a structure that covers all aspects of your business, from big categories to smaller, detailed accounts. Start with broad categories and leave room to add more specifics later.

  3. Choose Your Accounting Period: Decide if you want to track your finances monthly, quarterly, etc. This period will be the time frame for organizing your transactions.

  4. Name and Sort Accounts: Give each account a clear name. Organize them into main categories like assets, liabilities, equity, income, and expenses, and then break these down into smaller subcategories from there.

  5. Assign Account Numbers: Create a numbering system for each account to make them easy to identify. We recommend using the standard numbering system for COAs – 1000s, 2000s, 3000s, etc.

  6. Identify the Financial Statement: Each account is linked to a specific financial statement. Assets, equity, and liabilities will appear on your balance sheet, and revenue and expenses will appear on your income statement.

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Ecommerce chart of accounts example

Are you an ecommerce entrepreneur? Let’s look at a more specific example to your industry.

Imagine you have an online clothing store called The Boutique Muse. Your chart of accounts for The Boutique Muse might look like this:

ecommerce coa

This ecommerce chart of accounts provides a basic framework for an ecommerce startup. It tracks assets, liabilities, equity, income, and expenses, detailing some subcategories that might apply to your business.

Notice that account numbers and descriptions follow a consistent format. This makes it easy to record, categorize, and report financial activity over time!

SaaS chart of accounts example

Are you a SaaS entrepreneur? Here’s a more specific COA example to your industry.

Lumos is a SaaS startup offering solutions to businesses looking to maximize their data. A typical Lumos chart of accounts might look like this:

saas coa

This SaaS chart of accounts provides a basic framework for a SaaS startup. It tracks assets, liabilities, equity, income, and expenses, detailing some subcategories that might apply to your business!

Again, notice that account numbers and descriptions follow a consistent format. This makes it easy to track financial activity over time.

Best practices for your charts of accounts

A well-thought-out chart of accounts will simplify your accounting tasks down the road. Here are some best practices for your business’s COA:

  • Build your chart based on your industry and business model. Include accounts relevant to your functions and cash flow needs. This will yield a framework suited for your operations.

  • Use simple, descriptive names to define each account and keep your chart of accounts organized. Avoid vague or coded terms to ensure clarity, now and in the future.

  • Use an accounting software for accurate recording and financial reporting. Popular options like QuickBooks and Xero offer customization while automating routine accounting tasks.

  • Limit adding subcategories unless complexity adds value.

  • Review your COA on a frequent basis, updating it as your business grows and changes. Your COA should adapt and evolve just like your business does! Keep what works and change what doesn’t, removing categories that don’t add value anymore.

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Ready to outsource? We’ve got you covered

By now, you get the picture – categorizing and tracking your financials on a regular basis is key to success. But for entrepreneurs like you, we get it! Time is limited, and you’ve got other things on your plate.

That’s where our team of accounting experts comes in.

We’re here to help you build not only a COA, but personalized accounting solutions to fit your business’s unique needs. And as trusted advisors, we’ll work with you to understand your needs – an important step for your business’s financial health and long-term success.

Take the added to-dos of accounting off your plate so that you can do what you do best – growing your business. Book a free consultation with our team to get started today!

Frequently asked questions

Why is a chart of accounts important?

Why should you invest time and effort in creating and maintaining a COA for your business? The answer lies in the benefits below!

  • Organized = easy access

Having accounts properly categorized makes it simple to file away financial transactions neatly. Need that data later? You should have no issues finding specific transactions with an updated COA.

  • Preparing financial statements

A well-structured chart of accounts for your business simplifies creating those important financial reports. Without the COA framework, you’ve got a lot more sorting to do. Yuck!

How does a chart of accounts work?

A COA categorizes accounting records into basic categories using a numbering system. This allows tracking of assets, liabilities, equity, income, and expenses over accounting periods.

All accounting transactions are logged into the relevant common and individual accounts based on the account codes for easy tracking.

What are the common account types in the chart of accounts?

The main account types in a chart of accounts are assets, liabilities, equity, revenue, and expenses.