Debits and Credits – What’s the Difference?
Did you know that inaccurately tracking your debits and credits can get your business in trouble?
They are part of the accounting jargon that trips people up the most. Here’s everything you need to know about debits and credits, and what’s the difference between them.
Debit vs. Credit: Definitions
An important financial part of your role as a business is tracking and recording your transactions. If you leave them unattended for a while, your books will end up being unbalanced and sloppy (and you don’t want that!).
When recording your business transactions, debits and credits come into play. So, what are they exactly?
Debits represent all the money flowing out of your account, while credits represent all the money flowing into your account. Both of these terms are standard procedures when using double-entry accounting.
Accounting credits and debits affect one’s business differently. For example, debits will increase assets and expenses, while decreasing liability, equity, and revenue. On the other hand, credits will do the exact opposite – decrease assets and expenses, but increase liability, revenue, and equity.
To sum it up, for every transaction you record, there has to be at least one debit and one credit. Otherwise, you will have unbalanced books.
When using double-entry accounting, debits are recorded on the left side of your accounting journal. Credits are entered on the right side. By doing this, you are allowing yourself to track the money and see where the money you’ve spent will come from.
What Are Main Categories on the Chart of Accounts?
Every account in business books falls under one of these five main categories:
As we’ve seen above, debits and credits affect these categories. If you need a flashcard on this topic – we got you!
– Increase assets and expenses – Increase equity, liability and revenue
– Decrease equity, liability and revenue – Decrease assets and expenses
How to Tell What Is Debit vs. Credit in Accounting?
Business accounting can be confusing – especially for small businesses. Sometimes it’s hard to differentiate a debit from a credit. Some accounts are increased/decreased in different measures for different transactions. Here are a few tips on how to know is it debit or credit:
- Debits mean more assets (cash or utility accounts)
- Debits also mean less liability and equity
- Credits – less assets, but more liability and equity
If you are still having doubts about credits and debits in your business ledger – asking for professional help is the right thing to do. Professional accountants are familiar with double-entry accounting and will easier navigate through your business books to sort it out.
Example of Debit and Credit
For example, if you need to purchase a new machine for your business it would represent a credit in your business’s cash account because the money is flowing out of your account to purchase this machine. This item, however, automatically, becomes an asset you now own. Since the money didn’t simply vanish into thin air, an important thing to remember is to record the transaction with the appropriate debit. Even though, your account was credited, your equipment account was with a valuable machine. It is now your business’s asset, which you can sell use it for loans in the future.
You must familiarize yourself with how debits and credits work to keep your books without errors. Accurate books can paint you a better picture of your business’s financial health. Not to mention, you use debits and credits to prepare financial statements – the documents that you may need to share with your bank, accountant, the IRS, or an auditor.
Debits and credits are crucial in keeping your books balanced using the double-entry accounting method.
And, the most important lesson to remember – Credits increase as debits decrease and vice versa!
Your Part Time Accountant specializes in providing business accounting services for both owners of both medium and small businesses. If you need help with the complexities of bookkeeping and accounting – we are here for you!