Your business finances are made up of two components: assets and liabilities. The more of the former and the less of the latter appear on your balance sheet, the healthier your company’s finances are perceived to be. Accounting teams need to keep a close eye on a company’s acquisitions, debts, expense accounts, capital expenditures and other transactions by recording them as credits and debits.
The word debit is as old as the discipline of accounting itself. Yet its definition may not be clear to all SME owners. A debit may sound like something you owe. In fact, it is quite the opposite.
Debit and credit are essential in balancing a company’s accounts. A debit is an accounting entry that is created to indicate either an increase in assets or a decrease in liabilities on the business’s balance sheet. Credits, on the other hand, work in the opposite way.
When the sum total of all debits and credits matches, the company’s accounts are balanced.
Example of a debit
Whenever a debit is created by your business, a credit must be created elsewhere.
For instance, let’s say you run a store that sells shirts. If you sell $1,000 worth of shirts, you’ve gained $1,000 in your cash account. However, that $1,000 hasn’t come from nowhere. You are now without $1,000 worth of stock. As such, you would offset this debit to your cash account by crediting your inventory or asset account by $1,000.
However, if you needed to finance a new piece of equipment for your business, you would create a debit for your fixed asset account, and credit your liabilities to properly record the debt. New credit and debit accounts may also be added to track the new asset’s depreciation. The depreciation expense will be debited, while the accumulated depreciation is credited.
Likewise, if you invest in a new SaaS product, you will need to credit your cash account and debit your asset account accordingly every month, quarter or year, depending on the payment terms.
What is double-entry bookkeeping?
Double-entry accounting was pioneered by Franciscan monk Luca Pacioli in the 15th century. It was here that the terms debit and credit (from the Latin debitum and creditum) were first used.
Double-entry bookkeeping approaches every transaction as containing two sides, a credit and a debit. Whenever a debit is created somewhere in a business, a credit is inevitably created elsewhere, just as the shirt retailer example showed earlier.
When using double-entry accounting systems, accountants create something called a T-account. In its simplest form, this looks like a capital letter T used to divide credits and debits. Meaning that a debit is logged on the left side of the chart while a credit is logged on the right side.
Frequently asked questions about debits
What is a dangling debit?
A dangling debit is a debit that has no credit to balance it out. It usually arises when a business purchases goodwill in acquiring another company. Dangling debits are usually listed as deductions against equity accounts.
What is a debit note?
A debit note is used to prove that a company has created a legitimate debit entry in a B2B transaction. For instance, if you need to return goods to a vendor, you will need to create a debit note to validate the amount that is reimbursed to the company.
What are contra accounts and how do they work?
Contra accounts are used to reduce the value of related accounts. They work the opposite way to normal accounts. Thus, in a contra account, a debit decreases an asset rather than increasing it. They are typically used for valuation purposes.
This article is for informational purposes only and does not constitute legal, employment, tax or professional advice. For specific advice applicable to your business, please contact a professional.