K9 Bookkeeping is determined to make accounting and bookkeeping easy and accessible for business owners of every type.
This article is from our “Bookkeeping for Dummies” series, a part of that broader mission.
Starting your own business may be a dream come true, but it comes with so many challenges. One of the biggest challenges every business owner will face is learning all the business and accounting jargon you need to run your business effectively.
Debits and credits are an essential part of your business’s finances. In fact, they make up every aspect of your business’s finances! These terms are integral to understanding how your business is operating and where your finances are going.
If you’re struggling to understand these terms and how to apply them to your business’s finances, then don’t worry! We’re going to walk you through what debits and credits are and how they relate to different aspects of your business.
Related: Relieving Businesses Of The Burden of Bookkeeping
What Are Debits and Credits?
If you’re unfamiliar with these terms, then your first thought may be of a debit card versus a credit card. While that’s not a totally unrealistic comparison, it’s not an accurate portrayal of how these terms work in a business sense.
We’ll cover what exactly debits and credits are in relation to your business finances, so let’s dive right in!
Debits
Debits record all of the money that comes into your business accounts. Most businesses record their financial transactions in different accounts, as it helps them keep track of where money is going and makes it easier to file their taxes.
Let’s say that you have multiple accounts for your business. One account could be for all the cash you have in your business bank account, another could represent all the money you’ve received from loans, and another could represent the value of all your office supplies.
Debits relate to how much money gets added to these accounts. When an invoice gets paid into your business bank account, that money will be debited to that specific account.
Don’t worry because we’ll cover the topic of how debits work in practice further in this guide.
Credits
Credits are the opposite of debits. They represent all of the money that comes out of a specific account. Continuing with our earlier example, let’s assume a business has multiple accounts that record how much money is spent or received for different situations.
One account could represent all the money in your business’s bank account. Say you were to pay for an expense with your business bank account. The money you spent would be marked as credited to that account.
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How Do They Work In Practice?
Understanding how debits and credits work in practice can be a little confusing. Business finances can be a complex process. So, how do debits and credits work?
The basic rule to remember about debits and credits is that debits record all the money coming in, while credits record all the money going out.
So, if you were to receive a bank loan to make improvements to your office, the money received would be debited to your business bank account. However, that same sum of money would then be credited to the account that manages all of your loans.
In this instance, the credit increases the value of your loan account. This is because your loan account represents the amount of money you have, so you’re recording the increase in debt.
Another example would be spending money from your business bank account to purchase new office equipment. The money spent would be credited to your business bank account, while the value of the new office equipment would be debited to the account recording your office assets.
How To Record Debits and Credits Properly
Your finances are the backbone of your business, and ensuring that your accounts are being properly maintained will help prevent issues during tax season and make it easier for you to review the state of your business’s finances regularly. Recording your debits and credits properly is essential. This is something that needs to be kept up on every day.
A seasoned accountant or bookkeeper will understand how to record debits and credits correctly, but if you’re just starting out and planning on doing the work yourself, you’ll need to understand the basics.
Using a basic chart, debits should always be recorded on the left, while credits are always recorded on the right. Here’s a quick example:
The above example shows how to properly record debits and credits when you receive a bank loan. If your business receives a loan of $1,000, then you debit your business bank account while crediting your loan account.
Sometimes it can get confusing and hard to remember how debits and credits affect certain accounts. That’s why having a basic guide you can reference when needed is helpful.
Here’s a quick guide on how debits and credits affect certain accounts.
Debits
Increases:
- Asset Accounts
- Expense Accounts
Decreases:
- Liability Account
- Equity Account
- Revenue
Credits
Increases:
- Liability Account
- Equity Account
- Revenue
Decreases:
- Asset Account
- Expense Account
This guide is mostly covering the basics, but it’s enough for most people to take the plunge when they first begin keeping track of their business’s expenses. However, as you engage in more financial transactions, it will become harder to keep up on. This is when an experienced bookkeeper or accountant will need to step in.
Conclusion
Learning about debits and credits is essential for business owners. You need to know all your business’s ins and outs, especially your finances! Debits and credits record all your financial data and are the way that a professional bookkeeper or accountant will help you keep track of the money flowing in and out of your business.
A general guide to remember with debits and credits is this: debits record all the money coming in, while credit records all the money going out. Keep this simple rule in mind, and you’ll be a master of your business’s finances in no time!
Do you need a professional bookkeeper who can help manage your business’s debits and credits? Head on over to K9 Bookkeeping to speak with a professional today!
We’re happy you found this article informative! Go back to our blog page to find more tips, tricks and guidance on bookkeeping, to ensure your business is financially sound and ready to grow to the next level.
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