In Episode 35 of QuickBooks Mastery for Small Business Success, Erica Northrup and Lee Davis take a closer look at one of the most important—and often misunderstood—parts of QuickBooks: the Chart of Accounts.
If your Chart of Accounts is set up incorrectly, problems can show up throughout your financial reports. But when it is structured properly, it becomes a powerful tool for understanding your business, preparing for taxes, and making better financial decisions.
Listen to Episode 35
What Is the Chart of Accounts?
Think of the Chart of Accounts as the filing system for your business finances.
When you first set up QuickBooks, you are asked what type of business you have. That information helps QuickBooks create an initial Chart of Accounts.
But the Chart of Accounts is more than just a list of categories.
Each account belongs to a particular financial category, or “family,” and each one answers a different question about your business.
Imagine having a physical filing cabinet for your business. You might have one file for advertising, another for vehicle expenses, another for loans, and another for sales.
Those transactions are different because they tell different stories about your business.
QuickBooks uses the Chart of Accounts to organize those stories.
Six Questions Your Chart of Accounts Should Answer
Erica and Lee explain the Chart of Accounts by looking at the questions it should help your business answer:
- What does the business own?
- What does the business owe?
- How does the business make money?
- What belongs to the owner or shareholders?
- What does it cost to deliver the product or service?
- What is the business’s tax activity?
Understanding these questions makes it much easier to understand why your accounts are organized the way they are.
What Does the Business Own?
The first category involves your assets—things the business owns that have value.
Examples include:
- Bank accounts
- Petty cash
- Prepaid expenses
- Prepaid insurance
- Security deposits
- Vehicles
- Computers
- Property
Cash in your business bank account is an asset. So is equipment that your business owns.
These accounts appear on the Balance Sheet, which gives you a snapshot of what your business owns at a specific point in time.
What Does the Business Owe?
The next question is about liabilities.
Liabilities represent money your business owes to someone else.
Examples include:
- Credit cards
- Accounts payable
- Sales tax payable
- Payroll liabilities
- Lines of credit
- Vehicle loans
- Equipment loans
- Mortgages
- Notes payable
One important area where business owners can get confused is loans.
A loan payment isn’t simply an expense.
You generally need to separate the principal portion of the payment from the interest portion. The principal reduces the loan balance, while interest is treated differently for accounting and tax purposes.
If the loan is not set up correctly in QuickBooks, your financial reports can be misleading.
What Belongs to the Owner?
The Chart of Accounts also needs to account for equity—what belongs to the owner or shareholders after liabilities are considered.
Examples include:
- Owner’s Draw
- Owner’s Capital
- Retained Earnings
This can be confusing for business owners because they see money moving in and out of their accounts and naturally assume every transaction affects profit.
But that’s not necessarily the case.
For example, an owner’s draw is not a business expense. It is an equity transaction.
Understanding the difference between an expense and an owner’s draw is critical to having accurate financial reports.
How Does the Business Make Money?
Your Chart of Accounts also needs to clearly show how your business generates revenue.
This is where your income accounts come into play.
A business may have several different sources of income, such as:
- Service revenue
- Product sales
- Project revenue
- Other business income
How much detail do you need?
The goal isn’t to create hundreds of income accounts.
Instead, you want enough detail to understand the major areas of your business and compare them over time.
For example, being able to compare service revenue from this year to last year can help you determine whether that part of the business is growing.
Products and Services Matter
Your Products and Services in QuickBooks also need to be connected to the correct income accounts.
If products or services are categorized incorrectly, your revenue reports will not tell the right story.
That’s why the Chart of Accounts and Products and Services work together.
What Does It Cost to Deliver Your Product or Service?
Another important category is Cost of Goods Sold (COGS).
COGS represents the costs directly associated with producing the product or delivering the service.
Depending on the business, this could include:
- Materials
- Resale products
- Freight
- Direct labor
- Wages associated with delivering the work
Understanding your COGS is especially important because it helps you understand your margins.
If you don’t know what it costs to deliver your product or service, it becomes much harder to determine whether your pricing is profitable.
How Does the Chart of Accounts Help With Taxes?
The Chart of Accounts also plays an important role in tax preparation.
A properly organized Chart of Accounts helps categorize financial activity so your accountant can more easily determine what needs to be reported.
It can help identify things such as:
- Sales taxes
- Payroll taxes
- Income-related activity
- Deductible business expenses
- Assets and equipment
- Loan activity
The goal isn’t simply to make tax preparation easier.
Accurate categorization throughout the year gives you a better understanding of what your business owes and what financial obligations are coming.
Don’t Create Too Many Accounts
One of the common problems Lee and Erica discuss throughout QuickBooks Mastery for Small Business Success is creating too many accounts.
More detail isn’t always better.
If you have dozens of accounts that don’t provide meaningful information, your reports can become difficult to understand.
Instead, your Chart of Accounts should be customized to your business and structured around the information you actually need to manage it.
The Schedule C categories can provide a useful starting point for determining how expenses should be organized.
For businesses with multiple locations, divisions, or lines of business, QuickBooks classes can also provide another way to analyze financial information without creating an excessive number of accounts.
Your Chart of Accounts Should Work for Your Business
There isn’t a one-size-fits-all Chart of Accounts.
A landscaping company won’t necessarily need the same structure as a professional services firm, manufacturer, or construction company.
Your Chart of Accounts should reflect:
- How you make money
- What it costs to deliver your services
- What you own
- What you owe
- How owners are compensated
- What information you need for taxes
- What information you need to make business decisions
When the structure reflects the way your business actually operates, your QuickBooks reports become much more useful.
Final Thoughts
The Chart of Accounts may seem like a technical bookkeeping topic, but it is really about understanding your business.
When it is set up correctly, your Chart of Accounts can help you answer some of the most important financial questions a business owner faces:
How much are we making?
What does it cost us to make it?
What do we own?
What do we owe?
What belongs to the owners?
What do we need to prepare for taxes?
Your QuickBooks file is only as useful as the structure behind it. Taking the time to build the right Chart of Accounts can give you cleaner reports, better tax preparation, and a clearer picture of where your business stands financially.
As Lee Davis and Erica Northrup emphasize throughout QuickBooks Mastery for Small Business Success, the goal isn’t simply to have your books organized. The goal is to have financial information you can actually use.
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