What trips many small business owners up the most about bookkeeping? Debits and credits! There are times that business owners should understand accounting basics. At Bookkeeping Geeks, we commonly get asked,
“What does it mean to debit and credit an account?”
“Why is it debiting some accounts makes them go up, but debiting other accounts makes them go down?”
“How am I not understanding this essential part of running my business?!”
It’s important to know the numbers to get a true picture of how your business is performing. Plus, you can double-check the work of your accountant or bookkeeping software. Here we cover some bookkeeping basics and explain the basics of debits and credits.
What are Debits and Credits?
The simple answer is that debits record all money flowing into an account while credits record all money flowing out of an account. Don’t assume that all debits are bad or think that all credits are good. It’s all about balance.
Most businesses use a double-entry accounting system with debits and credits being the core of this system. Bookkeepers and accountants use debits and credits to balance each reported entry for a company’s balance sheet and income statement accounts.
Types of Debits and Credits
Here are the different kinds of debits and credits we commonly see for our clients:
- Income: A debit decreases income. A credit increases income.
- Expenses: A debit increases expenses. Credits decrease expenses.
- Assets: A debit increases assets while a credit decreases them.
- Liabilities: A debit decreases liabilities. A credit increases liabilities.
- Owner Equity: A debit increases equity while a credit decreases equity.
At Bookkeeping Geeks, we help entrepreneurs to understand their company’s financial health. We are happy to explain debits and credits and how they will impact different areas of their business. Our QuickBooks certified virtual bookkeeper is here to help; contact Dorothy Harvey today!
Why are Debits and Credits Important to My Business?
Under the double-entry method, an entire business is organized into individual accounts, i.e. assets such as cash and furniture and liabilities such as a bank loan.
When your business has a transaction – a product sells, furniture is purchased, a loan is taken out, money is spent on research and development – the amount of money in each specific account changes.
Recording what happens in each of these accounts as a debit or a credit lets you see where the money is going and where it is coming from.
Let’s say you recently spent $5,000 on office furniture. Because you spent cash and money went out, your “cash” account will be credited by $5,000.
At the same time, you increased the value of your furniture, and therefore you will have a debit of $5,000 in your “furniture” account.
In double-entry accounting, every debit (inflow) has a corresponding credit (outflow).
The example above showed what would be an entry of two assets (something that is owned). With liability accounts, things get trickier because these accounts show what is owed.
You just took out a $10,000 loan to expand your business. You increased your cash account (debit) by $10,000 but instead of a corresponding account decreasing, your bank loan account (a liability) also increased – but as a credit.
Why? This is because your bank loan account doesn’t measure what you have, but how much you owe. The more you owe, the larger the liability and value in the bank loan account. You are crediting the account, but the value of the account is increasing. The liability account keeps track of debt, and in this scenario, the debt is going up.
Need Bookkeeping Help?
Small business owners wear multiple hats, juggling several duties at once to keep your business up and running. If you’re still confused about debits and credits, Dorothy Harvey of Bookkeeping Geeks can help!
Contact us for more information on our virtual bookkeeping services such as accounts payable, budgeting, financial reports, and more, call our Tampa office at (813) 515-0216.