If you’re like most people, the only context you hear debit or credit applied to is at a cash register or bank account. But the reality is that debits and credits are vital to business transactions and the accounting that tracks these transactions.
That’s why they’re both crucial to understanding. So what’s the difference between debit and credit? And what are the different types of accounts associated with the transaction?
In this article, we’ll be answering these questions and more. That way, the next time you hear debris and credits, you’ll understand precisely what they’re referring to.
Table of Contents
What Are Debits and Credits?
Debits and credits are two concepts that are essential for recording business transactions in financial statements. Let’s start with debits. Debits are continuously recorded to the left of the accounting entry. In terms of increases, debits register your expense accounts or assets.
Alternatively, they can also decrease an equity account or a liability account. Credits, on the other hand, are recorded to the right of the accounting entry.
For increases, they deal with your equity or liability account. Or they can decrease an expense or asset account. But how are the two connected? Let’s take a closer look.
Are you interested in taking advantage of credits like the R&D tax credit? Check out TaxRobot’s software here to learn more about it.
Debits vs. Credits
It’s essential to think of debits and credits as inseparable. There can’t be credit without debit, and vice versa. That means that every time you enter something as a debit, you must also record that same amount as a credit. This balances the final transaction.
For example, you purchase a new computer for your business. The credit would go into your cash account because of your spending money on the computer. However, the laptop now becomes an asset to your company.
So, while your cash account ended up being credited, your asset list becomes debited with the cash value of the product. If you ever need to, you can sell the computer for collateral.
What Are the Different Accounts in Debit and Credit Transactions?
Double-entry accounting will always involve one account being credited and one debited. Let’s go over some of the different account types and how they’re debited or credited:
- Assets which include things like accounts receivable, cash, furniture, computers, and bank accounts — credit decreases the balance while debit increases it
- Liabilities which include things like accounts payable, bank and federal loans, and notes payable — debit decreases the ratio while credit increases it
- Revenue which consists of the money you make from your sales or services — debit decreases the balance while credit increases it
- Expenses which include the cost of business operations like payroll costs, insurance, supplies, and rent — credit decreases the ratio while debit increases it
- Owner equity which provides for your financial stake in the business — debit decreases the balance while credit increases it
Related: Understanding Convertible Debt
What Rules Govern the Use of Debits and Credits?
There are specific rules that govern how you record debits and credits. First, let’s go over changes to debit balances. Asset, expenses, and dividend accounts increase when a debit column is added and decrease when a credit column is added.
Revenue, liability, and equity accounts are the opposite. And the last rule, which is the most important, is that the total amount of debits and credits must match. If they don’t check, the accounts are unbalanced, so they can’t be input into accounting technology.
Examples of Debits and Credits in Accounting
Let’s see an example of debits and credits in accounting in action. Let’s say you’re a small business. You sell one of your products for $500. What would this look like as a debit and credit journal entry? A simple version would be something like this:
As you can see, this entry shows your cash asset increasing by $500. Meanwhile, the revenue account also increases with a credit entry.
This type of process is fundamental to basic bookkeeping. If you’re still feeling confused, check out our bookkeeping checklist to learn everything you need to know.
How Can Software Help Keep Track of Debits and Credits?
In the past, all business transactions were recorded in physical journals and ledgers. However, it’s becoming more common to keep electronic records using financial software. If you want to keep it old-school, you can use a pen and paper.
However, we highly recommend that you invest the time and energy in learning financial software that allows you to record entries quickly and easily. This will save you a significant amount of time down the road, plus it leads to more accurate records of business transactions.
We recommend hiring an accountant if you don’t have much experience with business transactions (for example, let’s say it’s your first startup).
They can walk you through the basics and get you set up for success. They’ll likely also be able to recommend good accounting software for your needs.
TaxRobot’s R&D tax credit software makes it easy to take advantage of credits that can save your business valuable money. Get in touch with us today to learn more about how it can help you.
The Importance of Understanding Debits and Credits
It doesn’t matter if you’re a business owner managing their budget or an accountant tracking a receivable turnover; you need to understand debits and credits. We know that making sure all of your spending and savings can be a pain.
But the sooner you learn it, the less of a headache you’ll have. You’ve likely heard the statistic that half of the new businesses fail within their first five years of operation.
The overwhelming reason? They weren’t able to keep an accurate account of their debits and credits. So make sure you prioritize this aspect of your business.
Related: Startup Consulting: Is It Worth It in 2022?