To properly track finances, small businesses should use an accounting system. One of the most important tools in an accounting system is the use of debits and credits. Accountants use debits and credits in a journal entry to change the amount of money in an account. Depending on the type of account being debited or credited, the account will increase or decrease. The type of account is the primary factor that determines the differences between credits and debits. It also is important to remember that for each journal entry, the amount debited will equal the amount credited.
A debit normally will increase an asset account. A credit will decrease an asset account. For example, if an accountant debits "Cash" for $50,000 and credits "Accounts Receivable" by $50,000, there is a $50,000 increase in cash and a $50,000 decrease in accounts receivable.
A debit will reduce a liability. A credit will increase a liability. For example, an accountant debits, "Accounts Payable" by $20,000 and credits "Cash" by $20,000. Here, the accounts payable is decreased by $20,000 because the company is paying $20,000 in cash to reduce it. If the journal entry was debit "Purchases" by $20,000 and credit "Accounts Payable" by $20,000, then the accounts payable increases $20,000 to cover the cost of the purchases.
Income accounts include revenues, gains, expenses and losses. If an accountant debits an income account, he is increasing an expense or loss. If an accountant credits an income account, he is increasing revenue or gains. For example, a company sells equipment for cash at a loss. He would debit "Loss on Equipment" and "Cash," then credit "Equipment." Debiting "Loss on Equipment" recognizes a loss. As previously stated, debiting "Cash" shows an increase in cash because the company received cash. Then crediting "Equipment" shows a decrease in the asset because the equipment is sold.
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