Chart of Accounts Explained for UK Small Businesses

A chart of accounts is the list of categories your business uses to sort every transaction, from sales and fuel to the bank balance and money owed to HMRC. A good one is short, uses plain names and lines up with your tax return, so that your reports mean something and year end takes hours and not days. This guide explains how it is structured and how to set one up that suits a small UK business.

Key takeaways

• Every chart of accounts has five groups: income, expenses, assets, liabilities and equity.
• Start from your software's default and trim it. Do not build from nothing.
• Fewer, clearer categories beat a long list. Consistency matters more than detail.
• Keep separate categories for anything with special tax treatment, such as entertaining, equipment and private use.
• Review the list once a year, not every month.

What is a chart of accounts?

Think of your bookkeeping as a filing cabinet. The chart of accounts is the set of labelled drawers. When you record a transaction, you are deciding which drawer it belongs in. At the end of the month or year, the totals in each drawer become your profit and loss account and your balance sheet.

In software these categories are usually called accounts, nominal accounts or nominal codes, and each often has a number as well as a name. The numbers are only there to keep related categories together and to make them quick to type. There is nothing magic about any particular numbering.

The five groups

Income less expenses gives profit. Assets less liabilities gives equity. If your categories sit in the right group, those two statements look after themselves.

Why it matters for tax

HMRC does not prescribe a chart of accounts, but it does require accurate records of income and expenses. The guidance on business records if you're self-employed and on company and accounting records sets out what must be kept. A sensible chart makes meeting those duties almost automatic, for three reasons.

• It maps to the return. The self-employment pages of a tax return group expenses under headings such as car and travel, premises costs and office costs. If your categories roll up into those headings, the return writes itself.
• It isolates the awkward items. Some costs are treated differently for tax. Client entertaining is generally not deductible. Equipment may be claimed through capital allowances and not as an ordinary expense. Costs with private use need adjusting. Giving each its own category stops them being buried.
• It supports Making Tax Digital. Under MTD for Income Tax, quarterly updates are sent from your digital records by category. See MTD digital records explained.

Sole trader vs limited company

The income and expense categories are much the same for both. The differences are mostly on the balance sheet.

• Sole trader. You need categories for capital introduced and for drawings, which is money you take out for yourself. Drawings are not an expense and are not wages. See bookkeeping basics for sole traders.
• Limited company. You need share capital, retained profit, a director's loan account, dividends, and liabilities for Corporation Tax and PAYE. Directors' salaries are a company expense, and dividends are not. See our guide to the director's loan account.

If you are VAT registered, you also need a VAT control category, which your software will normally create for you.

Step by step: setting up your chart of accounts

1. Start with the default. Use the standard chart that comes with your software, or the category list from a reputable spreadsheet template. Our software comparison can help you choose.
2. List what you actually spend on. Go through two or three months of bank statements and note the types of transaction that recur.
3. Remove what you will never use. Archive or hide categories that do not apply. A shorter list means fewer wrong choices.
4. Add what is missing for your trade. A driver might add platform fees and vehicle licence costs. A builder might split materials from subcontractor labour.
5. Separate the tax-sensitive items. Entertaining, equipment purchases, motor costs, use of home and anything with a private element.
6. Add one category per bank, card and loan account. Each real account should have its own, so each can be reconciled.
7. Write a one-line rule for each category. For example: "Software: monthly subscriptions for apps used in the business". This keeps you, and anyone helping you, consistent.
8. Set up bank rules. Tell the software where repeating transactions go, so most lines are categorised for you.
9. Review annually. Merge categories with almost nothing in them, and split any that have become a catch-all.

Worked example (illustrative)

"Sofia", an illustrative example, is a self-employed mobile hairdresser. Her software arrives with over 80 default categories. She keeps 24.

For income she has two: hairdressing services and product sales. For expenses she keeps hair products and consumables, motor costs, parking, insurance, phone, software, training, equipment under a set value, advertising, accountancy, bank charges and a few others. She adds a category called card reader fees, because her card payments arrive net and she wants sales shown in full. On the balance sheet she has her business bank account, a savings pot for tax, equipment, capital introduced and drawings.

In the first month she finds she is putting several different things into general expenses. She looks at what they are, moves them to proper homes, and then hides general expenses altogether. From then on, anything unclear goes into a single queries category that she clears with her accountant each quarter.

Sofia is invented for illustration and is not a real client.

Common mistakes

• Too many categories. Splitting stationery from printing from postage rarely tells you anything useful.
• A large general or sundry category. If it is more than a tiny share of your costs, it is hiding something.
• Treating drawings or dividends as expenses. They are not costs of the business and do not reduce taxable profit.
• Putting equipment into day-to-day expenses. Larger purchases should be identifiable so the right tax relief can be claimed.
• Changing categories mid-year. It breaks comparisons. Note the change you want and make it at the year end.
• Inconsistent choices. The same supplier coded three different ways makes every report less reliable. Bank rules fix this.

How we can help

We set up a chart of accounts that fits your trade and your tax return, apply bank rules, and keep the books reconciled each month. Bookkeeping starts from £150 per month on a fixed fee. See our Bookkeeping service, view our pricing, or contact us for a review of your current setup.