debits vs credits

Bookkeeping 101: Debits vs. Credits

4 min read • Oct 28, 2020 • Derek Miller

The foundation of good accounting is accurate and detailed bookkeeping. Much like you use a map when traveling, you should use your financial records to direct your business forward.

Bookkeeping starts with tracking debits and credits. Understanding the differences between these types of accounting entries can help you manage your business successfully.

Additionally, accurate books can ensure that your business reports correct numbers to the IRS and never encounters an account overdraft. Keep reading to better understand debits and credits and how to record them when bookkeeping.

What Are Debits and Credits? 

With the double-entry accounting method—which is the most popular—every transaction in your business creates both a debit and credit, which is recorded to the appropriate accounts. For single-entry bookkeeping, only the debit or credit is recorded in a single account. These entries track where the money comes and goes within your business.

If you’ve ever played golf (or at least seen a scorecard), then you understand the concept of debits and credits. After every hole, you input your strokes and add or subtract that score against par for the course. If you get a birdie, you subtract 1 stroke from your score. And if you get a bogey, you add 1. The act of adding or subtracting from your score is the same as debiting or crediting.

Businesses can have hundreds or thousands of debits and credits every month, depending on how many transactions they make. 

What’s interesting about debits and credits is that they have different effects depending on the type of account (see table below). For example, the transaction of paying your utility bill will create a credit for your accounts payable account and a debit for your utility expense account. 

As a result, debits (dr) record money coming into an account while credits (cr) report money leaving an account (to create value elsewhere). For effective bookkeeping, this flow of money is tracked as a journal entry and will indicate an increase or decrease to an account. On your accounting journal, debits will go on the left-hand side and credits the right.

To illustrate debits and credits, we’ll use 2 accounts: Cash and Materials. Let’s say you want to spend $500 on materials for your business. You would take $500 from your Cash account (credit) and put that $500 into your Materials account (debit). The act of crediting and debiting your accounts simply records how money flows within different areas of your business.

The table below demonstrates how the account changes based on whether you are making a debit or credit.

IncreasesDecreases
ExpensesDebit (dr)Credit (cr)
AssetsDebit (dr)Credit (cr)
LiabilitiesCredit (cr)Debit (dr)
RevenueCredit (cr)Debit (dr)
EquityCredit (cr)Debit (dr)

As you can see above, if you increase an asset account, it will require a debit, but if you increase a liability account, it will require a credit. These nuances can be complicated at first, but as you begin working with your books and consulting others as needed, you’ll gain more confidence and understanding of how to track the flow of money best for your business.  

How Are Debits and Credits Used in Double-Entry Bookkeeping?

Newton’s Third Law of Motion says that with every action, there is an equal and opposite reaction. Double-entry bookkeeping follows a similar principle—every transaction has an equal and opposite transaction (counter-transaction).

Because most businesses use double-entry bookkeeping, we’ll dive a bit further into debits and credits using this method. This form of accounting records every business transaction twice: both as a credit and a debit. 

For example, if you decide to open a restaurant, you may have $10,000 in cash saved up to start investing in your business. With this capital, you might buy a professional commercial stove and griddle for $3000. With double-entry bookkeeping, you would credit the cash account $3,000 (decreasing cash) and debit the equipment account that same $3,000 (increasing your equipment asset account).

DebitCredit
Equipment$3,000
Cash$3,000

 

Managing credits and debits in this manner can help you protect your business. You can fully understand the value of your small business and know where your money is flowing at all times. 

You don’t need to be a full-time account to keep good books. Accurate bookkeeping starts with attention to detail and good organization. To simplify the process, consider using a bookkeeping software tool like Lendio’s software, which can help you send invoices, track expenses, and make documentation easier come tax season. 

Bookkeeping not your jam? Outsource it to the professionals. Lendio provides professional bookkeeping services to take one more thing off your plate.

SHARE

Derek Miller

Derek Miller is the CMO of Smack Apparel, the content guru at Great.com, the co-founder of Lofty Llama, and a marketing consultant for small businesses. He specializes in entrepreneurship, small business, and digital marketing, and his work has been featured in sites like Entrepreneur, GoDaddy, Score.org, and StartupCamp.