Chart of Accounts

Your Financial Filing System

Every effective bookkeeping system starts with a chart of accounts. Without it, recording transactions is like filing papers with no folders—everything goes into one pile.

By the end of this lesson, you’ll build a working chart of accounts for a small business.

The Five Account Types

Every financial transaction in any business—from a lemonade stand to a Fortune 500—falls into one of five categories:

1. Assets (What You Own)

Things of value that your business possesses.

• Cash and bank accounts — Money in checking, savings
• Accounts receivable — Money customers owe you
• Inventory — Products you’ll sell
• Equipment — Computers, tools, machinery
• Prepaid expenses — Rent or insurance paid in advance

2. Liabilities (What You Owe)

Obligations your business must pay.

• Accounts payable — Bills you haven’t paid yet
• Credit card balances — Outstanding charges
• Loans — Bank loans, lines of credit
• Taxes payable — Tax obligations not yet paid
• Unearned revenue — Money received for work not yet done

3. Equity (Owner’s Stake)

The difference between what you own and what you owe.

• Owner’s investment — Money you put into the business
• Retained earnings — Profits kept in the business
• Owner’s draws — Money you take out

4. Revenue (Money Earned)

Income from business activities.

• Sales revenue — Money from selling products or services
• Service income — Fees for services rendered
• Interest income — Bank interest, investment returns
• Other income — Miscellaneous earnings

5. Expenses (Money Spent)

Costs of running the business.

• Rent — Office or workspace
• Utilities — Electricity, internet, phone
• Supplies — Office supplies, materials
• Payroll — Wages and salaries
• Marketing — Advertising, promotions

✅ Quick Check: Can you name the five account types from memory? Try listing them before moving on.

The Accounting Equation

These five types connect through one equation that must always balance:

Assets = Liabilities + Equity

This is the foundation of double-entry bookkeeping. Every transaction maintains this balance. If assets go up, either liabilities or equity must also change to keep the equation true.

Revenue increases equity (profits). Expenses decrease equity (costs). That’s why the expanded equation is:

Assets = Liabilities + Equity + Revenue - Expenses

Building Your Chart of Accounts

Here’s a starter chart for a freelance consulting business:

Numbering convention: 1000s for Assets, 2000s for Liabilities, 3000s for Equity, 4000s for Revenue, 5000s for Expenses. This keeps related accounts grouped together.

Common Mistakes

Too many accounts. Starting with 75 expense categories means you’ll spend more time deciding where things go than actually doing bookkeeping. Start with 15-25 accounts.

Too few accounts. A single “Expenses” account tells you nothing. You need enough granularity to understand where money goes.

Inconsistent categorization. Is your Zoom subscription “Software” or “Communication”? Doesn’t matter which—just pick one and stick with it.

Missing accounts. Forgetting Owner’s Draws means personal withdrawals get categorized as expenses, inflating your costs.

Customizing for Your Business

Different businesses need different accounts. Here are additions by business type:

E-commerce: Add Inventory (1400), Shipping Costs (5900), Merchant Processing Fees (6000), Cost of Goods Sold (5050)

Restaurant: Add Food Inventory (1400), Beverage Inventory (1410), Kitchen Equipment (1310), Food Cost (5050)

Freelancer: Add Subcontractor Payments (5900), Client Retainers (2300, liability), Home Office Deduction (5650)

Try It Yourself

Build a chart of accounts for your business (or a hypothetical one):

1. List all your income sources → These are your Revenue accounts
2. List all your regular expenses → These are your Expense accounts
3. List everything you own for business → These are your Asset accounts
4. List everything you owe → These are your Liability accounts
5. Add Owner’s Equity and Owner’s Draws

Use the numbering convention above. Keep it under 25 accounts to start.

Using AI to Help

Try this prompt with any AI assistant:

“I run a [type of business]. Help me create a chart of accounts with the standard 5 account types. Keep it under 25 accounts and use the numbering convention: 1000s Assets, 2000s Liabilities, 3000s Equity, 4000s Revenue, 5000s Expenses.”

AI is excellent at generating starter charts. Your job is to review and adjust based on your actual business needs.

Key Takeaways

• Five account types: Assets, Liabilities, Equity, Revenue, Expenses
• The accounting equation (Assets = Liabilities + Equity) must always balance
• Start with 15-25 accounts—expand only when needed
• Use consistent numbering: 1000s, 2000s, 3000s, 4000s, 5000s
• Consistency in categorization matters more than perfect categories

Up Next

In Lesson 3: Recording Transactions, you’ll start using your chart of accounts to record actual business transactions with debits and credits.