Many people struggle with understanding this accounting concept, but it’s worth persevering, because it’s a fool-proof way to make sure that the numbers in your accounts are correct. Every number is entered twice, and then the accounts are balanced. If they don’t agree, you know you’ve got a mistake somewhere. This simple method has also often been used to uncover major frauds by employees.
What are debits and credits?
The whole concept of double entry bookkeeping rests on debits and credits. As well as cash in and out, these items also show how cash is being moved around your business.
For example, when someone buys something from you, you receive cash (these days probably electronically but it’s still called cash). So you’ll record that transaction as a credit in the cash summary. But you’ve also removed the sold item from the business. The business now owns fewer things. So you write the same thing down as a debit on your goods summary. These summaries are actually mini accounts within your business.
You may decide that you want to track cash, invoice payments, money owed by clients and tax due to be paid. When a client pays, that’s a credit on the cash account and a debit on the “money owed by clients” account. But you may also decide when a client pays that it should activate a debit on the cash account and a credit to the same amount on the VAT due account.
In effect you are moving the VAT money from one part of the business to another. So it’s a debit to the cash account and a credit to the VAT account.
There’s more information here on debits and credits and how to define them: https://www.accountingweb.co.uk/community/blogs/dvphilippines/basic-understanding-of-debits-and-credits-in-accounting.
Get help setting up the accounts
If you don’t see yourself being able to be a double entry expert, but don’t need a full time bookkeeper, Cheltenham accountants https://www.randall-payne.co.uk/ can help you by setting up the books and showing where the entries should go.
The real strength of double entry bookkeeping is that the same sum coming in, going out, or moving within the business, generates a debit in one place and a credit in the other. So it’s easy to check that the accounts are correct, because when they are balanced, everything should net off to zero.