Okay, deep breaths. If the words “debits” and “credits” make your eyes glaze over or trigger flashbacks to a confusing accounting class, you’re not alone. For many new entrepreneurs, this is one of the most intimidating parts of bookkeeping.
But here’s the good news: you don’t need to be a CPA to grasp the basics. Understanding debits and credits is simply about understanding how money moves within your business. Getting this right is the foundation for accurate financial records, which helps you track profitability, manage cash flow, and stay prepared for tax time.
Let’s break it down the easy way.
The Golden Rule: It All Starts Here
Everything in bookkeeping revolves around one fundamental concept:
The Accounting Equation: Assets=Liabilities+Equity
Let’s translate:
- Assets: Stuff your business owns. Think cash in the bank, equipment (computers, tools), inventory you plan to sell, money customers owe you (Accounts Receivable).
- Liabilities: Stuff your business owes to others. Think bank loans, credit card balances, money you owe suppliers (Accounts Payable).
- Equity: The owner’s stake in the company. This includes your initial investment and the profits your business retains over time. Revenue increases Equity, while Expenses decrease Equity.
This equation must always stay in balance. Always. Every single business transaction affects this equation, and that’s where debits and credits come in.
Meet Debits (Dr) and Credits (Cr): Two Sides of the Same Coin
Forget trying to intuitively guess if debit means “increase” or “decrease.” Instead, think of them simply as:
- Debit (Dr): The LEFT side of an accounting entry.
- Credit (Cr): The RIGHT side of an accounting entry.
That’s it! They are just labels for the two sides used to record every transaction.
The magic is in Double-Entry Bookkeeping. This means every transaction affects at least two accounts. To keep the Accounting Equation balanced, the total amount of debits MUST equal the total amount of credits for every single transaction.
The Key: How Debits & Credits Affect Different Accounts
Here’s the part that usually trips people up. Whether a debit or a credit increases or decreases an account depends entirely on the type of account.
Here’s a simple way to remember:
| Account Type | Increases With… | Decreases With… | Think… |
|---|---|---|---|
| Assets | Debit (Dr) | Credit (Cr) | (Things you Own) |
| Expenses | Debit (Dr) | Credit (Cr) | (Things that reduce Profit) |
| Liabilities | Credit (Cr) | Debit (Dr) | (Things you Owe) |
| Equity | Credit (Cr) | Debit (Dr) | (Owner’s Stake / Net Worth) |
| Revenue / Income | Credit (Cr) | Debit (Dr) | (Money Earned, increases Equity) |
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(A common mnemonic: DEA – Debits increase Expenses and Assets. LER – Credits increase Liabilities, Equity, and Revenue.)
Let’s See It In Action (Simple Examples)
This makes more sense with real-world examples:
Example 1: You buy $100 worth of office supplies using your business debit card.
- What happened? You gained supplies (an Asset) and spent cash (also an Asset).
- Accounts affected: Office Supplies (Asset) and Cash (Asset).
- Applying the rules:
- Office Supplies (Asset) increased. Assets increase with a Debit.
- Cash (Asset) decreased. Assets decrease with a Credit.
- The Entry:
- Debit (Dr) Office Supplies $100
- Credit (Cr) Cash $100
- (See? Debits = Credits, and the equation stays balanced)
Example 2: You perform a service and receive a $500 cash payment.
- What happened? You received cash (an Asset) and earned revenue (which increases Equity).
- Accounts affected: Cash (Asset) and Service Revenue (Revenue/Equity).
- Applying the rules:
- Cash (Asset) increased. Assets increase with a Debit.
- Service Revenue (Revenue/Equity) increased. Revenue increases with a Credit.
- The Entry:
- Debit (Dr) Cash $500
- Credit (Cr) Service Revenue $500
- (Balanced again!)
Example 3: You pay your $1,000 monthly rent bill with cash.
- What happened? You incurred a rent expense (an Expense, which decreases Equity) and spent cash (an Asset).
- Accounts affected: Rent Expense (Expense) and Cash (Asset).
- Applying the rules:
- Rent Expense (Expense) increased. Expenses increase with a Debit.
- Cash (Asset) decreased. Assets decrease with a Credit.
- The Entry:
- Debit (Dr) Rent Expense $1,000
- Credit (Cr) Cash $1,000
- (Still balanced!)
Why Does This Matter?
Understanding this system, even at a basic level, helps you:
- Ensure Accuracy: It’s a self-checking system. If your debits don’t equal your credits, something’s wrong.
- Gain Insight: It forces you to think about how each transaction truly impacts your business financially.
- Prepare for Taxes: Accurate records built on this foundation make tax filing much smoother.
- Make Better Decisions: When you understand how money flows, you can make smarter choices about spending, pricing, and growth.
Don’t Panic! Take it Step-by-Step
Does it feel a bit clearer? It takes practice! The good news is that most modern bookkeeping software (like QuickBooks, Xero, Wave) handles the debit/credit entries behind the scenes when you categorize transactions.
However, knowing the logic behind it helps you troubleshoot issues, understand your financial reports, and feel more confident about your business finances.
If you’re still feeling stuck, that’s perfectly okay! That’s what bookkeepers are here for. Don’t hesitate to reach out for help setting up your system or making sense of your numbers.
Key Takeaways:
- Everything balances around Assets=Liabilities+Equity.
- Debits (Dr) = Left side, Credits (Cr) = Right side.
- Every transaction has equal total Debits and Credits.
- Whether Dr/Cr increases or decreases depends on the account type (Assets, Expenses vs. Liabilities, Equity, Revenue).
You’ve got this! Understanding the flow of money is a crucial step in building a successful business.