Over the weekend I had a very pleasant conversation with a stranger on a plane, smart person, pushing to start a business, and yet also making his life way harder than it should be, and way more stressful, over the apparently frightening and loathsome phrase “debits and credits.”
Come on, this isn’t that difficult. If you can do everything else — and you’ll have to — then this is something you can learn in 10 minutes. Try it. Read this post and end the sweaty palms syndrome forever. (And, yes, by the way, if you recognize some of this, I’ve written it before, and posted it here. But six years ago. Time for a refresh. And besides, that guy on the plane — you know who you are — didn’t believe me.
To ClarifyYou don’t have to know debits and credits to do a business plan. As I say elsewhere, planning is not accounting. You don’t need to be an MBA or CPA to develop business plan financials. You need to be able to make reasonable assumptions and follow the financials, preferably using Liveplan or Business Plan Pro.
Still, some simple understanding is useful, and easy. Debits and credits originally appeared as part of the double-entry bookkeeping system that supports the entire world of financial accounting, planning, and analysis.
It starts out with a simple accounting sheet, as you see here. You write the item in one column, the debit in another, and the credit in a third.
You’ll notice that the single transaction has two entries, one of $635.32 for the sale and the other for the related $635.32 for the cash. Here’s another:
It can get a lot more complicated than that, but with these examples you can see the foundations of the system. Here are some built-in standards that might help.
- Every transaction has to have equal amounts for debits and credits. Accounting must always balance debits and credits. That’s were the word “balance” comes from.
- The amount of a sale is normally a credit. A debit to sales is the same as a refund. It reduces sales.
- Costs and expenses are normally debits. You debit the expense account and credit the way it was paid (as in the checking balance or cash) or not paid (as in Accounts Payable).
- An increase in an asset is always a debit. An increase in a liability is always a credit.
- An increase in capital (for example, a new investment) is always a credit. A new investment is a credit to capital and a debit to the checking account.
And that’s it. It’s not rocket science. It’s not voodoo. It’s debits and credits.
Footnote: my older brother, who was a very successful prosecutor before he retired, a fighter or white-collar criminals in the Silicon Valley, once proclaimed to me: “double-entry bookkeeping is the most important invention of western civilization.” Say, what? And he’s not an accountant. But that one made me think.