What is a chart of accounts?
The chart of accounts (COA) is a listing of all accounts that appear in an accounting system’s general ledger for a business. At a glance, it can provide a transparent and digestible overview of the structure of your accounts and similar groupings of accounts. As such, it’s exhaustive but not necessarily intended to be a tool of analysis.
Instead, a chart of accounts provides business owners (and other stakeholders) a bird’s eye view of the company’s day-to-day operations at a glance. Of course, a full listing of accounts also empowers stakeholders to do a deeper dive if they want to go beyond a perfunctory look at a business’s accounts.
Why create a chart of accounts?
Because the chart of accounts showcases a full listing of your company’s accounts, it’s a great way to track money coming in and going out. It’s also ordered into broad account types such as assets, liabilities, revenue, or expenses. The chart of accounts then orders specific accounts under these categories.
Think of it as a filing cabinet for your company's accounting system: The level of organization and clarity that a chart of accounts affords your business means that you’ll be in a better position to keep your finger on the pulse when it comes to your company's financial standing.
Because it’s a complete and accurate listing or index, a chart of accounts can be a significant part of helping an external stakeholder better understand how a company has set up its financials. If they (or you, as the business owner) are looking for a detailed look at the current state of all the operational pieces that fit together.
Each chart of accounts consists of main categories (the broader categories like cash, fixed assets, prepaids, accounts payable, revenue, and cost of goods sold) and subcategories (detailed categories that break down where Cash is going, whether it’s into Chase Savings or Chase Checking). These correlate with a numerical identification code.
Depending on the size of your company, the chart of accounts may have only a few account subcategories or hundreds.
Why is the chart of accounts important?
A chart of accounts matters because it acts as an easy-to-read financial tracker of your business. It answers the question: Where is the money going, and where is it coming from?
With the chart of accounts, you have an overarching view of your business’s financial health—which you can use to attract investors, ensure your company remains profitable as you scale, or simply get a clearer understanding of where money flows in and out of the company.
But that’s just the tip of the iceberg. Here’s why you need to become familiar with your chart of accounts:
Reason #1: Gain clarity on a company level
The chart of accounts helps break down all financial transactions into categories. The more organized the chart of accounts is, the more useful the information presented in it. As a result, it helps businesses determine the effectiveness of how different business layers perform. You can also use this information to decide what actions to take, such as how to improve specific areas that require your attention.
Reason #2: Organize finances better
The chart of accounts provides a complete listing of all accounts, which you can structure according to your needs. For example, you can divide revenue and expenses based on the business function, product type, or company division.
This makes it easier to find particular accounts across hundreds and thousands of them. It provides a bird’s eye view of what is happening within certain business functions or divisions based on account-specific information. It also provides an understanding of which products or services are providing the most revenue if you have organized the chart of accounts that way.
Reason #3: Adhere to financial standards
The chart of accounts provides a standardized way to break down finances because, with subcategories, you get a better idea of what’s going on financially than with some other types of financial statements. And with the help of accounting software, managing accounts becomes easier.
Translation: Less human error.
It improves reporting standards by driving consistency across the entire company and different business units. This consistency then translates into comparability, which is essential when expanding with new product lines or growing into new verticals.
How does the chart of accounts lay the foundation for double-entry accounting and vice versa?
A chart of accounts showcases all accounts according to the order they follow in the financial statements. So it starts with assets, liabilities, and equity for balance sheet accounts, followed by revenue and expenses for the income statement accounts.
Since the chart of accounts creates a listing of all accounts as found within the general ledger, it contributes to the creation of the double-entry bookkeeping system as well. In other words, the chart of accounts lists all the information provided in the general ledger and then uses specific codes to denote the bookkeeping transactions.
In such a case, each transaction makes two entries, one for the debit and one for the credit. This is called double-entry accounting, which is a bookkeeping method where you track where your money comes from and where it goes. This is important to ensure the accuracy of accounts listed in the chart of accounts.
Some of the main features of the double-entry method include:
- Two parties: There is a receiver and a giver.
- Equal effect: Books should be balanced with the sum of each debit and accompanying credit being equal to zero.
- Separate legal entity: Each accounting system is separated from the owners.
- Debit and credit: There are two aspects to each transaction, namely the debit and the credit elements.
So, for example, if a business takes out $10,000, the cash (the asset) is debited $10,000, and the outstanding debt (the liability) is credited $10,000.
At first glance, it might seem like the double-entry system is an unnecessary extra step or yet another thing to learn and keep track of. But there are plenty of reasons why expert bookkeepers worldwide depend on this system: It produces fewer errors, offers more detailed data, and is more efficient in the long run.
- Fewer errors: It helps accountants reduce mistakes and detect fraud early on.
- More detailed information: It provides complete information about a transaction, which enables better. decision-making for all stakeholders, including management, investors, creditors, and auditors.
- More efficiency: It’s a recommended system for most businesses due to better efficiency in recording different financial transactions.
It becomes important to the chart of accounts as the information provided results in an accurate listing of all accounts and related revenues and expenses.
The double-entry method is based on the principle that every debit must have an opposite credit with two accounts for every financial transaction.
Here are a few rules to keep in mind regarding debit and credit:
- Recorded on the left side of the ledger sheet
- Shows an increase in the asset account
- Reveals a decrease in the equity or liability account
- Displays a reduction in revenue
- Shows an increase in the expense accounts
- Recorded on the right side of the ledger sheet
- Shows a decrease in the asset account
- Reveals an increase in the equity or liability account
- Displays an increased revenue
- Shows a reduction in the expense accounts
You have an online store, and you’ve just sold 20 products. You have been credited with $20 cash for these products, which means you also have $20 in the income account. For the charts of accounts, this type of information can be summarized under the profit & loss statement as it relates to the cost of goods sold with a specific number to denote the account and, later on, to locate it.
You pay your monthly rent of $1,200 in cash. Every time you do this, you credit the cash asset account because that cash is no longer in the business. And every time you do that, you also debit your expense account for rent.
Quick Tip: Worried about keeping track of this? If you involve automation in this process, the credit and debit accounts update accordingly.
Chart of accounts in practice
Let’s imagine you have a small business called Crumbs Bakery. Your chart of accounts for Crumbs Bakery might look like this:
As we can see from the example above, a chart of accounts shows four different parts: Number, account description, account type, and the financial statement that each sub-account belongs to. Let’s break each section down to understand it better:
First, you need to determine the numbering system since it helps identify and link accounts. The first digit showcases the account type or broad category—assets, liabilities, equity, revenue, or expenses.
Then the sequential number indicates the specific account or subcategory. The Crumbs Bakery example shows that the cash account corresponds with 1010. The equipment account is number 1510. Both of these subcategories fall under the umbrella of assets, the broad category linked to numbers that start with 1000.
(But keep in mind that, as your business grows, you’ll want larger account numbers that can accommodate your chart of accounts. Most businesses have account numbers that are four or five digits long.)
Creating an organized number system for all your account categories and subcategories helps accountants see how all the areas of your business involved with making or spending money fit together.
Each account needs to have a corresponding description. This helps identify the relevant item or subcategory. For example, the Crumbs Bakery account number 2010 shows that we have accounts payable (a liability) for that particular listing, while bakery supplies (an expense) are account number 5000.
Each account type is divided into five main account types: Assets, liabilities, equity, revenues, and expenses. All subcategories—the specific account descriptions—fall within one of these account types.
All the account types are either part of income statements or balance sheets. In this instance, the current liabilities listed in Crumbs Bakery’s chart of accounts belong to the balance sheet statement.
Balance sheet accounts
Balance sheets provide a snapshot of where the company stands regarding what it owes and what it owns. They are prepared at the end of a specific period—typically monthly.
Three different types of balance sheet accounts are required to create a balance sheet: Assets, liabilities, and equity.
Asset accounts refer to anything your business owns and considers of value. Main accounts may be cash, accounts receivable, insurance, inventory, and fixed assets—and sub-accounts existing under asset accounts may include:
- Raw material
- Finished goods
- Money market accounts
Liability accounts are the debts your company owes. Main accounts might be Accounts Payable, Notes Payable, Payroll Liabilities, and Accrued Expenses. Sub-accounts existing under these liability accounts include
- Company’s credit card balance
- Wages payable
- Invoices payable
- State taxes payable
- Rent payable
Income statement accounts
Income statement accounts are used to create another important financial statement. Income statements—also called profit and loss statements—can be generated monthly, quarterly, or annually to interpret your company's profitability during a given time.
Revenue accounts keep track of the income stream your company brings from revenue sources like:
- Sale of goods
Expense accounts include what your business has spent on your overhead and operating expenses. This includes:
- Licenses and Insurance
How to set up your chart of accounts
You know that a chart of accounts is an important way to organize your finances and crucial for potential investors, lenders, and shareholders.
When pitching to an investor or lender, you must ensure that you have all of your documentation accurately prepared—including your chart of accounts.
Luckily, setting up your own chart of accounts can be pretty straightforward if you follow these steps:
Step #1: Create business account names
Make sure you create clear account names—and stick to them. Naming your accounts prevents confusion about the transaction, thus making it easier to provide accurate financial report insights.
Step #2: Assign unique account numbers
Each category should get a unique number used in the corresponding financial statement. For example, all assets can belong to the range of 1001-1099; liabilities can be 2001-2099, and so forth.
Step #3: Organize account names into account types
Each account name should belong to one of the five main account types: Assets, liabilities, equity, revenue, and expenses. This way, you can distinguish between specific accounts as needed.
Step #4: Use automated software to keep track of your accounts
Manually tracking every bit of income and expense can be daunting, especially if you’re just starting out and don’t have a separate bookkeeper yet. Automated tools like expense management software can create essential documents, including charts of accounts, income statements, and balance sheets.
Save time with financial software that makes staying organized easy
As your business grows, you need quick and accurate reporting—and the chart of accounts offers a bird’s eye view of all the accounts involved in your business operations, allowing you to easily add accounts as your business grows and your accounting becomes more complex.
But keeping track of all your accounts and paying bills on time can be challenging if you don’t have the right tools. The good news? BILL can help you create and pay bills, send invoices, and get paid—all in one platform. Learn more about BILL today!