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3 steps to structure an optimal chart of accounts for your business

Posted by Neha De

August 29, 2022

A chart of accounts is a crucial element of accounting, explicitly bookkeeping, which allows a business owner to identify and keep track of all monetary transactions their business engages in. This part of the company’s general ledger breaks down and organizes financial activity into categories.

To keep records more organized, a chart of accounts follows a numbering system. It allows small business owners to keep their financial transactions systematic, as it provides a snapshot of the firm’s financial standing.

There are six basic account categories on a chart of accounts: assets, liabilities, revenue, expenses, cost of goods and equity.

Assets

– Assets comprise anything that has value and can be converted into cash. This includes cash, inventory, equipment, vehicles, any short- and long-term investments and accounts receivable (money owed on outstanding invoices).

Liabilities

– This includes money or obligations a business owes, such as any taxes, debts, insurance and accounts payable.

Revenue

– The amount a company earns from providing its services to clients falls under the revenue category. This includes commissions, sales, revenue from dividends or interest, earnings from investments and payments from clients.

Expenses

– Expenses are the funds an organization spends in an effort to earn money, that is, the costs of generating business revenue. This includes office rent, office, utilities, salaries and so on.

Cost of goods sold

– Cost of goods sold (COGS) comprises all direct expenses associated with a product, that is, the direct cost of production. It does not include overheads such as taxes, operating expenses or interest payments. This category does not apply to service-based businesses.

Equity accounts

– Equity refers to an ownership interest in a company. It is what a business owner is owed, or what is left of the assets after a business’ liabilities are paid. Equity includes owner’s capital, retained earnings, common, preferred and treasury stock, and cash dividends.

How to structure a chart of accounts for your business



As the first step in setting up your company's accounting system, establishing a chart of accounts begins with organizing financial information. Check out the three-step process to making a chart of accounts:

Step 1: Set up parent accounts

– Parent accounts help categorize your distinct business sub-accounts by category. The six basic account categories on a chart of accounts are assets, liabilities, revenue, expenses, cost of goods and equity.

Step 2: Develop your business’ accounts

– Creating accounts for your company will depend on the type of business you run. For instance, accounts that are common for service-based companies are cash, sales, accounts receivable, accounts payable and income tax payable.

Categorize these account sub-categories into the relevant parent account. For example, cash and accounts receivable will come under assets.

Step 3: Allocate account numbers

– A chart of accounts is based on a numbering system, which helps organize all the different accounts. This numbering system depends on the number of expected transactions for a business. For example, numbering for a small product-based business can be done as follows:

Assets: 100–199
Liabilities: 200–299
Revenue: 300–399
Expenses: 400–499
Cost of goods sold: 500–599
Equity: 600–699

On the other hand, for a large product-based business, the numbering can be done as follows:

Assets: 1000–1999
Liabilities: 2000–2999
Revenue: 3000–3999
Expenses: 4000–4999
Cost of goods sold: 5000–5999
Equity: 6000–6999

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