Every transaction you make will lead to (at least) two entries in your accounts, a debit and a credit. More complex transactions may lead to a larger number of postings, but the total of the debits for that transaction will always be equal to the total of the credits.
The two entries are:
These are both good for the business.
This simple situation is complicated slightly if the business is VAT registered. Say a sale is made for £100 excluding VAT with credit terms given to the customer. Here the double entries are:
Note that although there are three transactions, the total of all the debits and credits still agrees.
This is often shown in a “T” account, where debits are always shown on the left, and credits on the right (if you live in the UK this is because you DRive on the left, and CRash on the right (debits and credits are often abbreviated to Dr & Cr)
Again, using the good/bad analysis:
At a later point the customer will hopefully pay for their purchase. At this point you credit debtors (to remove the amount owed) and debit your bank balance. Of course at the end of your VAT quarter part of that cash will go to HMRC to clear the VAT creditor.
For more complex transactions it is not always easy to tell where the debits and credits will go. Typically if you can work out where one side goes, and you know whether it is a debit or a credit (use the patronising but useful good/bad system above!), you can then figure out where the other side will end up.
If double entry bookkeeping is done properly, you’ll know where every penny comes from and goes. Every single transaction will be explained properly, and there won’t be any “unknown differences” written off. Of course, this is in an ideal world, and is based on everything always being posted to the correct place.
The combination of all the various debits and credits to date can be summed up in the trial balance. This shows all the different balance sheet and profit and loss items in a big list with the debit or credit balance of each one. Of course, when you sum all the credits together, and all the debits together, the total of each column will be the same. If not you’ve got a real problem!
By now you should know that having a positive balance in your current account will be a debit (a positive balance is a good thing!). Increasing that balance would be a debit, and decreasing it would be a credit.
So why when you look at your bank statement is it the wrong way around?
It isn’t…for the bank. The bank produces the statements from their point of view. If you have a positive bank balance, that means the bank owes you money, so to them it is a credit.
Maslins offer a complete accountancy solution for freelancer/contractor businesses for just £99+VAT/month.
