Debit vs. Credit: What's the Difference?
The terms "credit" and "debit" likely sound familiar. Most people probably have experience using credit cards and debit cards for their bank accounts, for example. However, when it comes to business accounting, these terms have slightly different meanings.
As accounting terms, debits and credits are part of bookkeeping. When managed correctly, they should balance each other out. A debit will be an entry that marks an increase in an asset or expense account. It marks everything coming into the business. On the other hand, a credit increases liability and decreases asset accounts.
Since they perform opposite functions, you can see how they enable you to achieve account balance. For example, if a business buys $7,000 worth of inventory, a bookkeeper will mark an increase, or debit, in their asset account. At the same time, they will mark a decrease, or credit, in their cash accounts.
With this method of accounting, each debit marked needs to have a corresponding credit. This method of bookkeeping — where each accounting transaction receives two records to show how it flows in and out — is known as the double-entry accounting method.
For those new to accounting, Skynova offers accounting software that makes it easy to manage different books and records with step-by-step assistance for startups and small businesses. This article will walk you through what debits and credits are and how to use them, so you feel prepared to take control of your business's accounting.
What Is a Debit in Accounting?
A debit entry represents an increase in the assets or expense account. When considering your liability account or equity account, though, a debit will decrease the amount of money in the account.
This can be confusing. Imagine the different accounts as jars of beans. When you increase your assets, you'll pour more beans into this jar. When dealing with accounts like equity or liabilities, those bean jars represent money that you have to pay to others. Your liabilities might be loans, for example, that you have to make regular payments on. Your equity is what will get paid out to stakeholders. Therefore, when your business brings in more money and you debit those accounts, the total amount of money you owe will decrease.
If you pay off a bank loan and debit your liabilities account with the amount you paid, the total amount you owe has gone down. In this situation, debiting decreases the amount listed in the account.
What Is a Credit in Accounting?
On the other hand, a credit entry in accounting represents money leaving the business. It's the opposite of the debit. This means where a debit increases the amount listed in an account, the credit will decrease it. Conversely, in accounts where the amount goes down with a debit, the amount will go up with a credit.
When you credit accounts associated with what the business owns, namely asset or expense accounts, the credit will decrease the amount listed. With accounts that represent the amount of money your business owes in the form of liabilities or equity, the credit increases the amount listed because now the business owes more.
Examples of Debits and Credits
Understanding the difference between credits and debits can be confusing; let's walk through two examples of how businesses might record their accounting.
A local electrician must spend $7,000 upgrading some of their equipment. When they make this purchase, the equipment will increase assets on the equipment account line. Therefore, in this scenario, the electrician will need to debit the fixed assets account with the $7,000 because the business gained $7,000 worth of equipment.
However, since the business also spent $7,000, the electrician will need to credit their payable account. This makes the $7,000 easily traceable from the accounts payable to the increased assets.
A local marketing company has begun to see tremendous success and wants to invest in company growth. They decide to take out a loan for $4,000 so they can position themselves for expansion. In this situation, the company will need to debit their cash account by $4,000 because now they have more available from the cash back they received from the bank.
However, with the double-entry system, they will also need to credit their liabilities account since they just increased the amount owed to the bank. Therefore, they will increase their liabilities by $4,000 by crediting that account.
Bookkeeping 101: How to Record Debits and Credits
To begin recording your business transactions, you'll need to first divide your books up into relevant accounts, generally assets, expenses, liabilities, equity, and revenue. In accounting, within each account, the debits are always listed on the left side and credits have a place on the right side.
Once a business transaction takes place, you'll record it within two opposite accounts, crediting one and debiting the other to show the flow of money within your organization. Taking out a loan, for example, will debit your asset account but credit your liabilities account.
We'll now go over the types of items included within these five main accounts and how they're influenced by credits and debits.
Your asset account tracks everything that your business owns and offers economic value. This might include real estate, business equipment and tools, cash, vehicles, accounts receivable, or inventory.
The items you track here will vary depending on your type of business. For a retailer, the inventory account might be the largest asset, while a limousine company will have its vehicles as a large portion of this account. Consider all the different assets that could be liquidated to help you determine what should go here.
Since this particular account represents what your company owns, debits to this account will increase the amount in your account, while credits will decrease the amount listed.
Expenses include everything that costs the business throughout the year, such as wages or salaries for employees, travel expenses, supplies for the business, and utilities. This account represents the value that the business brings in through these expenses. It offsets the owner's equity and, therefore, has debit increases and credit decreases.
The revenue account tracks the cash earned through sales and services provided, interest earned from investments, and related activities that generate revenue for the business. Revenue causes the owner's equity to increase and is increased by credits and decreased by debits.
A liability account records items that indicate debt that needs to be paid. For example, you would include items like accounts payable, income tax payable, bank fees, and anything else owed to another person or business. Since this account clearly indicates money leaving the business, it sees increases in amounts with credits and decreases in amounts with debits.
Your equity account is calculated by subtracting your liabilities from your assets. This account will also increase with credits because this is the money that gets paid to the owner or shareholders. It's essentially a liability to the owner or stockholders. Equity can be found in various places, including stocks and bonds, investment accounts, and real estate.
Let Skynova Help You With Your Small Business Bookkeeping
It can be hard to understand how to manage the balance sheet and successfully become a bookkeeper for your startup or small business for those new to the system. Fortunately, now that you see the difference between credits and debits from a business perspective, you're setting yourself up for success.
To help business owners manage their accounting simply, Skynova offers accounting software and a host of products and templates to make it easy to track expenses, income, and financial statements. The accounting software also uses double-entry bookkeeping to improve accuracy and general ledger features to help business owners manage their expenses.
These software products can help small business owners track their business transactions and simplify their bookkeeping. Managing business accounting has never been more straightforward.
Notice to the Reader
The content within this article is meant to be used as general guidelines regarding credits and debits and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting accounting standards.