Setting Up Your Chart of Accounts the Right Way

Your Chart of Accounts Is the Foundation

Think of your chart of accounts (COA) as the filing system for every dollar that moves through your business. Get it right, and your financial statements make sense, your tax prep is painless, and you can actually see where money goes. Get it wrong, and you end up with a mess that nobody — including you — can interpret.

Most accounting software gives you a default chart of accounts when you set up. Most of those defaults are mediocre at best. Here is how to set it up properly.

The Five Account Categories

Every account falls into one of five categories. This is not optional. This is how accounting works.

1. Assets (What You Own)

These are numbered in the 1000s range.

1000 — Cash and Bank Accounts: Checking, savings, petty cash
1100 — Accounts Receivable: Money owed to you by customers
1200 — Inventory: If you hold stock (skip if service-only)
1300 — Prepaid Expenses: Insurance, rent, or subscriptions paid in advance
1400 — Fixed Assets: Equipment, vehicles, property
1500 — Accumulated Depreciation: Offsets fixed assets over time

2. Liabilities (What You Owe)

Numbered in the 2000s.

2000 — Accounts Payable: Money you owe to vendors and suppliers
2100 — Credit Cards: Balances on business credit cards
2200 — Payroll Liabilities: Taxes withheld, benefits owed
2300 — Short-Term Loans: Lines of credit, notes due within a year
2400 — Long-Term Loans: SBA loans, equipment financing, mortgages

3. Equity (Your Ownership Stake)

Numbered in the 3000s.

3000 — Owner's Equity / Capital: Initial investment and retained earnings
3100 — Owner's Draws: Money taken out by the owner
3200 — Retained Earnings: Accumulated profit kept in the business

4. Revenue (What You Earn)

Numbered in the 4000s.

4000 — Service Revenue: Your primary income from services
4100 — Product Revenue: If you also sell products
4200 — Other Revenue: Interest income, rental income, miscellaneous

Keep revenue categories aligned with your actual business lines. A general contractor might have 4000 — New Construction Revenue, 4100 — Renovation Revenue, 4200 — Service/Repair Revenue.

5. Expenses (What You Spend)

Numbered in the 5000s through 6000s. This is where most businesses need the most detail.

Cost of Goods Sold / Direct Costs (5000s)

5000 — Materials and Supplies
5100 — Subcontractor Costs
5200 — Direct Labor
5300 — Equipment Rental (job-specific)
5400 — Permits and Fees

Operating Expenses (6000s)

6000 — Rent / Lease
6100 — Utilities
6200 — Insurance
6300 — Office Supplies
6400 — Marketing and Advertising
6500 — Professional Services (legal, accounting)
6600 — Vehicle Expenses
6700 — Meals and Entertainment
6800 — Software and Subscriptions
6900 — Repairs and Maintenance
6950 — Depreciation Expense

Rules for a Clean Chart of Accounts

Keep It Granular Enough to Be Useful

"Miscellaneous Expense" should never be more than 5% of your total expenses. If it is, you are not categorizing properly.

But Not So Granular That It Is Noise

You do not need a separate account for every type of office supply. Pens and printer paper can share an account.

Match Your Tax Return Categories

Look at Schedule C (sole proprietor) or Form 1120/1120-S (corporation). Your expense categories should map to the line items on those forms. This makes tax prep dramatically easier and cheaper.

Use Consistent Naming

Pick a convention and stick with it. "Marketing and Advertising" not "Ads" in one place and "Marketing Costs" in another.

Number Your Accounts

Use a logical numbering system. Leave gaps between numbers so you can add accounts later without renumbering everything.

Common Mistakes

Too few accounts. Dumping everything into "General Expenses" means you cannot see where money actually goes.
Too many accounts. Having 200 expense accounts when 40 would do creates confusion and inconsistency.
No separation between COGS and operating expenses. This kills your ability to calculate gross margin.
Mixing personal and business. Your chart of accounts is for business transactions only.
Never reviewing or cleaning up. Accounts accumulate. Once a year, review and consolidate or remove accounts that are no longer relevant.

Setting Up in Your Software

In QuickBooks, Xero, or any accounting software:

Start with the default chart of accounts
Delete or rename accounts that do not apply to your business
Add accounts specific to your industry and operations
Set up numbering if the software supports it
Create sub-accounts where helpful (e.g., 6600 Vehicle Expenses > 6610 Fuel > 6620 Maintenance > 6630 Insurance)

Spend an hour getting this right at the beginning, and you will save dozens of hours throughout the year.

The Bottom Line

Your chart of accounts is not exciting, but it determines whether your financial statements are useful or useless. Build it with intention, match it to your tax return, and keep it clean. When you pull up your P&L and can immediately see exactly where your money is going, you have done it right.