Bookkeeping Basics
Chart of Accounts for Small Business: What It Is and How to Set One Up
Quick answer
A chart of accounts is the list of categories your accounting software uses to sort every transaction. Accounts fall into five types: assets, liabilities, equity, income and expenses. A good chart is short enough to use consistently, specific enough to answer your real questions, and shaped around how your business makes and spends money.
Every transaction in your books lands in an account. The full list of accounts is your chart of accounts. It decides what your profit and loss statement and balance sheet can tell you, so it is worth getting right early.
The five account types
- Assets: what the business owns, such as bank accounts, receivables and equipment.
- Liabilities: what it owes, such as credit cards, loans and sales tax payable.
- Equity: the owner's stake, including contributions, draws and retained earnings.
- Income: money earned from customers.
- Expenses: costs of running the business.
Start from the questions you want answered
Do you want to know what each service line earns? What rent costs against sales? How much goes to payroll? Create accounts for the answers you will actually use. Too few accounts hide things. Too many make it hard to categorize consistently.
Keep income specific, expenses practical
Separate income by the main things you sell, such as products and services, or by location. For expenses, use categories you would recognize in a meeting: software, advertising, insurance, rent, supplies. Avoid a large miscellaneous account, because it becomes a place where problems go to hide.
Owner draws and personal spending
Money taken out by the owner is not an expense. It belongs in an equity account such as owner draws or distributions, depending on how the business is structured. Your CPA can tell you which applies. Keeping it separate prevents the business from looking less profitable than it is.
Industry-specific accounts
Some businesses need accounts that a generic chart lacks: job costs for a contractor, cost of goods sold for a seller, or tip liability for a restaurant. See how this looks in practice for construction, restaurants and retail.
Changing a chart that has grown messy
A short worked example
Imagine a small design studio. Its income accounts might be Design Services, Retainers and Reimbursed Expenses, so it can see which kind of work brings in money. Its expenses might include Contract Labor, Software Subscriptions, Advertising and Professional Fees. Meals, travel and equipment each get their own account because they are treated differently at tax time.
Notice what is missing: dozens of one-off accounts for every vendor. Vendor names belong in the vendor field, not in the account list. If you find yourself creating an account for a single transaction, a broader account with a clear description is usually the better choice.
Do not delete accounts that have history. Rename them, merge them with a careful review, or mark them inactive. Merging accounts changes past reports, so do it with your bookkeeper or CPA. If your books need a reset, our catch-up bookkeeping service covers cleanup, and you can talk to us about your file.
Frequently asked questions
How many accounts should a small business have?
Enough to answer your real questions and few enough to categorize consistently. Many small businesses work well with a modest list rather than hundreds.
Can I change the default chart in QuickBooks or Xero?
Yes. Both let you add, rename and deactivate accounts. Review the effect on past reports before merging.
Where do loan payments go?
Split between interest, which is an expense, and principal, which reduces the loan liability. Recording the whole payment as an expense overstates costs.
Who decides how my chart should look?
You decide what you want to track. Your bookkeeper sets it up for that, and your CPA confirms it works for tax reporting.
Should I let my software's default chart stand?
It is a reasonable start, but review it. Rename accounts to match how you talk about your business and hide the ones you will never use.
Who decides which accounts to use for taxes?
Your CPA can tell you if certain costs, such as meals or equipment, need to be separated for tax reporting. Ask before the year starts, not at filing time.
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Written by
Moshe
Senior Account Manager, Mispar
Moshe is a Senior Account Manager at Mispar who works directly with small business owners and freelancers to keep their books clean, reconciled, and tax-ready every month.
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