There are a lot of things people don’t tell you about being a small business owner before you get started. Between serving customers, managing employees, keeping your books up to date, and struggling to build the reputation of your brand, it’s a constant process of learning on the job.
Also, you probably didn’t realize that opening your own business would require you to become an accountant by default. Accounting is essential for every business, and you get thrown into the deep end when you start a new company.
Without training in this field, accounting terms can feel like a foreign language. While we can’t provide an entire accounting education in this article, we can address one common issue – how to tell debit vs credit accounting transactions. If you have been struggling with how to understand credit vs debit in accounting, the content below should put you on the right track.
What are debits vs. credits?
Let’s make this very clear – for the non-accountant, debits and credits can be confusing. If you can’t seem to get your mind around this topic, don’t worry – you are far from alone. We’ll try to break it down as simply as possible to give you a basic understanding of what’s going on here.
Before we talk debits and credits, let’s quickly talk about the underlying accounting system in question – double-entry accounting. This method is used nearly universally, and it requires that each transaction will involve two accounts (thus the double-entry name). So, whether money is coming or going, each transaction is going to be marked by two entries in the ledger that balance each other out. We’ll offer an example later in this article to help clarify this concept.
So, back to debits and credits. Your double-entry accounting system is organized into a variety of accounts. In your accounting system, you can see the accounts you have established in your “Chart of Accounts”. When money is going into one of those accounts, that’s known as a debit. If money is going out of an account, that’s a credit. On the most basic level, that’s what you need to remember – debits are adding to accounts and credits are taking away from those accounts.
What is an example of debits vs credits?
Let’s walk through a quick example to help you fully understand how debits and credits work in practical application. For this example, we are going to assume that you have decided to purchase $2,000 worth of inventory for your business. This purchase is going to be made with cash out of the business account.
When you make that purchase, two entries will be required – one debit and one credit. The debit is going to be placed in the inventory account because it is being increased (you have added to your inventory). So, a debit of $2,000 is applied to the inventory account.
The complementary entry is a credit of $2,000 to the cash account. This subtracts from your cash account the amount of money that has been spent. So, after both entries have been made, you are left with an accurate picture of what this transaction meant for your business – you own $2,000 more inventory, and you have $2,000 less cash in your account.
How do debits and credits affect my liability accounts?
You’ll need to reverse your thinking when it comes to liability accounts. The liability accounts your business uses will depend on how you operate, but one common example for small businesses is accounts payable. This is a liability because balances in this account represent money that you owe to your suppliers and other vendors.
A debit applied to a liability account is going to have the opposite effect as a debit applied to an asset account. So, the $2,000 debit we applied to inventory in the example above increased the value of the inventory account, since that account is an asset. However, if a $2,000 debit were applied to accounts payable, the balance of that account would decrease, since it lives on the liability side of the ledger.
It’s a good idea to add to your accounting knowledge as a business owner, so dealing with topics like what is debit vs credit in accounting is a worthwhile endeavor. With that said, you don’t want to be spending your time in the back office, buried in the books. Instead, you should be out front, helping your business grow by offering valuable products and services to your customers.
How can you make that vision a reality? Turn to Xendoo. Our accounting and bookkeeping services will streamline your operations without breaking the bank. With Xendoo on your side, you won’t need to turn yourself into an accounting wizard – just hand the books over to us and rest assured that they will be done correctly month after month. Let’s get started!