Double Entry Bookkeeping Explained
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If you’re self-employed or running a small business, understanding double-entry bookkeeping is essential for maintaining financial stability, making informed decisions, and keeping all your hairs on your head.
So in this article, we’ll walk you through the fundamentals of double-entry bookkeeping, share practical examples, and guide you through this accounting method. We’ll go over the following:
What Is Double-Entry Bookkeeping?
Double-entry bookkeeping is an accounting method that ensures your business transactions are recorded in at least two accounts using debits and credits.
A debit increases one account while a credit increases another, resulting in balanced financial records. This system tracks transactions accurately, providing a complete perspective of a company's financial health.
That said, transactions may be recorded in more than just two entries. The term "double-entry" bookkeeping simply means that every transaction requires a debit and a credit record for a balanced accounting system. Usually, the more complex the transaction, the more entries you’ll need.
The Difference Between Single-Entry and Double-Entry Accounting
Before diving deeper into double-entry bookkeeping, it's essential to understand the difference between single-entry and double-entry accounting systems:
Single-entry accounting involves recording transactions only once, either as a debit or credit in a single account. It's a simpler approach often used by smaller businesses.
Double-entry accounting goes a step further, recording each transaction in multiple accounts with both a debit and a credit. This method provides a more comprehensive fuller financial picture, showing not only expenses and revenues but also the impact on different accounts like inventory and cash.
Who Should Use Double-Entry Bookkeeping?
Double-entry bookkeeping is ideal for small businesses with multiple employees or those seeking to apply for a loan. It gives smaller companies precise and organised records of their transactions, so they can better understand their financial position and make well-informed decisions down the road.
Plus, with clear records of income, expenses, assets, and liabilities, you can present a reliable financial snapshot to lenders and stakeholders. This increases your credibility and chances of securing loans or investments.
What Are the Rules for Double-Entry Bookkeeping?
In double-entry bookkeeping, a few straightforward rules ensure accuracy and balance in recording financial transactions.
You’re already familiar with rule number one: every transaction must have at least one debit and one credit entry.
Rule number two is that the total debits must always equal the total credits. In accounting 101, you’ll see an equation that looks like this:
(Assets = Liabilities + Equity)
In simple terms, the value of everything a company owns (assets) must always be equal to the sum of what it owes (liabilities) and what the owners or shareholders have invested (equity).
For example, if a company has $20,000 in assets, $8,000 in liabilities, and $12,000 in equity, the equation remains balanced.
Rule number three is that debits record increases in assets and expenses, while credits record increases in liabilities and equity.
Conversely, debits decrease liabilities and equity, while credits decrease assets and expenses. Like a see-saw, one side goes up, and the other goes down to keep everything in balance.
That way, your books stay balanced and up-to-date.
The Different Types of Business Accounts
In double-entry bookkeeping, you use different types of accounts to categorise and track various aspects of your business's financial transactions. The five main types of accounts used in double-entry bookkeeping are:
- Asset Accounts: Asset Accounts: These represent what your business owns, like cash, inventory, and equipment.
- Liability Accounts: These show your business's debts and obligations, such as loans and bills to pay.
- Income Accounts: These track the money coming into the business, like sales and earnings.
- Expense Accounts: These record the money going out of the business, like rent, salaries, and other costs.
- Equity Accounts: These reflect the business owner's investment and the profit left after expenses. It's like the ownership share in the company.
Debits and Credits
Debits and credits are terms used to describe the two sides of every transaction.
Think of debits as "+" and credits as "-".
Debits are used to record when something is added to accounts like assets or expenses. On the other hand, credits are used when something is taken away from those same accounts or when revenue, equity, or liabilities increase.
Think of debits as adding money to an account, like paying off a bank loan, which decreases the liability account. And think of credits as taking money out of an account, like getting paid for a service, which increases the revenue account.
Every transaction has both a debit and a credit so that they can balance each other out. The result is always a zero balance in each account.
Examples of Double-Entry Bookkeeping
If you’d like to understand how double-entry bookkeeping applies in real-life small business scenarios, here are a couple of examples:
Let’s say you’re a business owner ready to pay her monthly rent. You pay £800 in cash for the monthly rent of your store.
In double-entry bookkeeping, here's how this transaction would be recorded:
- Debit the Rent Expense Account: Increase the rent expense by £800 to reflect the store’s rental cost. (Expense account)
- Credit the Cash Account: Decrease your cash by £800 since you paid the rent in cash. (Asset account)
Now, another quick example. Let’s say you’re a freelance designer who decided to invest in £200 software (equipment) for your work. This transaction would be recorded as follows:
- Debit the Equipment Account: Increase the value of your design equipment by £200, representing the new software. (Asset account)
- Credit the Cash Account: Decrease the cash by £200 since you paid for the software in cash. (Asset account)
See how each transaction balances each other out? That’s the magic of it!
Why Is Double-Entry Bookkeeping Important?
Firstly, double-entry bookkeeping ensures precise and reliable financial records by recording transactions in multiple accounts.
And when you have a clear idea of your business’s (cash)flow, you can make strategic and informed decisions about where to invest and grow – and where to cut back on costs, making resource management simpler than it would’ve normally been.
Of course, we have to think of the tax man, too! Properly organised financial records simplify the tax filing process and reduce the risk of compliance issues. Plus, if you’re looking for investments or loans, accurate financial records instil confidence in potential investors or lenders.
How to Get Started with Double-Entry Bookkeeping
Now that you're more versed in double-entry bookkeeping, you have two choices: you can get hands-on with your accounting or let experts deal with the whole process for you.
The process itself isn’t complicated. However, things tend to get confusing when you're trying to do it yourself with only a basic understanding of double-entry bookkeeping – while running a business at the same time.
But with a solution like Outmin, you can take off your accounting hat and let us handle the numbers for you. Our platform offers end-to-end accounting and bookkeeping services, including:
- Balance sheets
- Payroll management
- Year-end accounts and filings
- Bank reconciliations
- And anything else related to your business’s accounting
- Plus - fractional CFO services ensure you’re moving in the right financial direction.
You’ll no longer need to struggle to gather paperwork and documents – all you have to do is upload them to our platform. Our accounting professionals and cutting-edge AI technology will take care of the rest.
Get paired with experts who do all your accounting for you, starting from £199/month. That’s 50% more cost-effective than a traditional accountant!
Interested in Outmin and how we can help you? Get a demo today!
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