No matter which accounting system your startup uses, at its heart is the chart of accounts (COA), an indexed list of accounts with classifications. After you’ve attributed each transaction to an account, you’ll establish your general ledger and use double-entry bookkeeping to keep your books in balance. Your COA is a reflection of your business’ financial structure and should provide the amount of detail you’ll need to generate your financial statements.
In a nutshell, a COA is designed to track and report your income and expenses. It’s best to rely on a professional for set up and maintenance, but you still need to understand what’s involved and how it impacts your business. Here are the basics:
Create a classification
Your Chart of Accounts should include some or all of the following elements:
Assets: File under assets everything that your startup owns or is due, including future payments. Include current and fixed assets, accounts receivable, and inventory, as well as accumulated depreciation for each asset.
Liabilities: Include everything you owe under liabilities, including future debt. Liabilities include short-term items such as accounts payable, payroll and sales taxes, and long-term ones like a mortgage.
Owner’s equity: Basically, this category includes all of your investment in your business. Include both common stock and preferred stock, even if you don’t have investors yet to account for future external capital contributions.
Revenue: This category will primarily comprise sales from your products or services, but you can also include accounts for sales discounts and/or returns. Think about including any interest-bearing accounts you have for income earned on company investments. And don’t forget about keeping track of your cost of goods sold as well as related sales costs.
Expenses: The Schedule C IRS Form is a good starting point for keeping track of expenses. Beyond what’s included there: advertising and marketing, employee benefits, professional services services, you can add additional line items for other costs that are specific to your business.
The future is now
You undoubtedly envision that your startup will grow and shift. When you set up your accounts, keep that vision in mind, because it will help you think about what accounts you may need three to five or even seven years from now. For instance, you might only be a two person business for now, but at some point in the future, you’ll need to hire staff. Keep this in mind when setting up your COA.
Be a numbers person
Luckily, you don’t need to be a librarian—or an accountant—to set up a robust numbering system. Your COA can be a simple 4-digit system where the first two digits denote a category and the last two indicate subcategories. For instance, all liabilities might be classified under “2000,” with each further assigned to subcategories under 2010, 2020, 2030, etc.
Get rid of accounts you don’t need
Figure out which are essential for your startup and don’t bother with extraneous accounts. If you are providing services, for instance, you really don’t need to include an account for inventory.
Go into detail
Some accounts that are specific to your industry may require more detail than other categories do. Legal and professional services, for instance, are costs that you may want to break down into individual accounts.
Keep it dynamic
Your COA is not set in stone. As your company evolves, you’ll probably find some accounts become obsolete while others you may need to add others you hadn’t initially considered. Fine-tune the COA to keep it in sync with your financial plan.
At the end of the day, the value of your chart of accounts is in how much it supports your financial decision-making. Keep adjusting yours until you’re satisfied it meets your needs.