Regardless of what accounting system your startup uses, at its core will be the chart of accounts (COA). A chart of accounts will differ from company to company, but the common thread is that it is a system of your accounting records that aligns with your financial structure and offers the level of detail required in your financial statements. More specifically, it’s an indexed list of accounts that shows classifications and sub-classifications that are impacted by your financial transactions. Once you’ve assigned your transactions to an account (and its corresponding number), you can then set up your general ledger and use double-entry bookkeeping to ensure that your books are balanced.
In other words, your chart of accounts is an accounting system, designed specifically for your company, that helps you track and report your income and expenses. I would, of course, recommend working with a professional, but, even if you outsource this task, it’s still important for you to understand how to properly set up your own chart of accounts to best serve your business needs. Here’s how:
Set up your categories. There are five essential categories you’ll want to consider for your chart of accounts:
- 1. Assets – everything your company owns (or is owed), including current assets. fixed assets, accounts receivable, inventory. In this category, also include an account for accumulated depreciation for each asset.
- 2. Liabilities – everything your company owes (or may owe). Current liabilities include your accounts payable and taxes (both payroll and sales). Long-term liabilities might include a mortgage or some other long-term debt account.
- 3. Owner’s equity – your business investments. This account should include common stock and preferred stock, in the case that you have investors at some point.
- 4. Revenue – Sales revenue is your primary source of income. You may also choose to include accounts for sales discounts or returns. It’s also a good idea to create an interest income account for any income earned on company investments. Consider, too, the cost of goods and other related sales costs under your revenue account.
- 5. Expenses – For expenses, you may want to start with the Schedule C IRS Form. While the point of your chart of accounts isn’t merely to help you to file your taxes, this tax form is still a good starting point to build on for creating your expense account. This form includes such things as advertising, contract labor, employee benefits, legal and professional services, repairs, and more.
Contact Early Growth Financial Services for help identifying and tracking your expenses and all your other financial needs.
Look to the future. Your business will grow and change, so, when setting up your accounts, don’t just think about your current accounts, but also consider those you may need in the future. For example, you may not have any employees, but you likely will build out your staff at some point so take this into account.
Create a numbering system. Typically your chart of accounts will be established as a four-digit numbering system. Each category of accounts will share the initial digits and then the following digits will be used for sub-categories.This gives you room to grow and add additional accounts. For example, your assets category could be assigned to 1000. Each asset in this account would then be assigned in sequence: 1000, 1010, 1020, etc.
Delete irrelevant accounts. Of course you’ll want to pick and choose the accounts that are relevant to your startup, and leave out the rest. For example, if your startup is service-oriented, then you won’t have any inventory to account for. This is where you have to personalize your chart of accounts.
Add more granularity. Depending on your business, it may make sense to offer a greater level of detail in some categories.For example, if one of your expenses is for multiple legal or professional services, you may want to break these services out into separate accounts.
Fine-tune your chart of accounts. As with any financial document or plan, your chart of accounts isn’t static. As your startup grows, you may find that it makes sense to add or delete particular accounts. Keep working with it until it is aligned with your financial plan.
There’s no one perfect chart of account. You just want to tweak your accounting system until you have what you need: the necessary information to make solid financial decisions for your startup.
Questions about creating your chart of accounts? Let us know in comments below or contact Early Growth Financial Services for accounting support.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial and accounting services to companies at every stage of the development process. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.