Credits, Debits and the Double Entry System
Developing a system to manage your business’ financial transaction can seem very daunting, and to the average lay person it is. Debits, credits, accounts, double entry – all foreign terms to the average entrepreneur with a great business idea. Rely on your someome to set up your accounts in the way that makes the most sense, while being the easiest to understand, for your business.
It all starts with a chart of accounts. A chart of accounts is a list of accounts financial transactions can be recorded in. Depending on the size of a company and the complexity of its business operations, the chart of accounts may have as few as twenty or as many as a thousand accounts. Each company has the flexibility to tailor the chart of accounts to best meet its needs, and those needs vary depending on the industry the business operates in. A marketing firm has different income potential and expenses than a construction company, for example. A great business will not only set up your accounts in a way that makes the best sense for your business, but will also communicate the rationale behind the chart of accounts to you in a way that you fully understand.
Once you have your chart of accounts, credits and debits will be listed to accurately record financial transactions of your business. So what exactly is a credit, and what exactly constitutes a debit? When money is spent, a debit occurs. When money is received, a credit occurs. Confusion sets in however when using the double-entry system because both a debit and a credit entry are completed for each financial transaction, whether you are paying a bill or getting a check. The key is knowing which account to credit, and which one to debit, and how that affects the bottom line. The Dividends, Expenses, Assets and Losses accounts are increased with a debit and decreased with a credit, where Gains, Income, Revenues, Liabilities and Stockholders’ Equity accounts are increased with a credit and decreased with a debit.
The bottom line is that at any point in time, the balance of a company’s assets will equal the balance of its liabilities and equity accounts. If at any point the sum of debits for all accounts does not equal the corresponding sum of credits for all accounts, an error has occurred and must be corrected. And if that is not enough to keep up with, other errors can occur when the transaction is recorded in the wrong account, or if the entry is recorded in revers (a debit where it should be a credit).
Rely on experience to set up and maintain your accounts on a regular basis in order to accurately report the financial position of your business so you can focus on what you do best – running your company.