Avoid Debits and Credits – what they are and how to avoid them!

Don’t Let Accounting Geek-Speak Freak you out….
These easy tricks will make you a business wiz AND help you avoid techy stuff!

Firstly, stop worrying about how complex accounting seems, lots of terms; cut through financial jargon…Take a different approach.

Tip: Start by seeing accounting as a “convention”
Accounting is just a set of rules that helps everyone sing from the same song sheet, the same as driving on either the left or right side of the road, or using one type of Alphabet or another – and, as with many conventions; terms and names differ from country to country and region to region. Even different English speaking countries, England, US, Canada, Australia use different accounting terms to mean exactly the same thing. Worse, a single person, such as your own accountant, will happily, and consistently, be inconsistent in their jargon!

Avoid Debits and Credits – what they are and how to avoid them!

So, rather than thinking about how unfriendly it all is, go with the flow.

You don’t need to get all the terms right, or know every title! However, you do need some basic concepts under your belt, and ideally over time to become familiar with a broad range of possibilities. Luckily although there are a lot of terms these terms do not refer to very many things, in fact there are only a few fundamentals – all you need to do is comprehend the basics and the jargon mostly becomes irrelevant.
 

Background – How did Debits and Credits come about?

Tip: The main objective of any, and every, report is to provide useful information for making informed decisions.
As a business operates opens their doors, then grows the growing complexity adding to the business impairs the ability to simply KNOW, and remember, what went on, and what resulted, becomes harder and harder…There are staff to monitor, more customers and clients and products and services in the mix and the larger the mix the greater the need for some way of keeping track.

Accounting was invented to record information about:

  1. What is going on in a business – money earned and money spent, this is shown on your Profit and Loss Report
  2. Outcomes and Results of what has gone on what you own and owe, this is shown on your Balance Sheet Report

Debits and Credits evolved as the names for how the records are made. Double Entry Bookkeeping is the process that records information to about both what has happened (Ins and Outs) AND what resulted (Owns and Owes); it links the two financial reports together.

Debits and Credits are a “Double Act”

Tip: Debits and Credits are simply the twins of record keeping – For every Debit there needs to be a Credit
These confusing words are simply the names used to differentiate each identical half from the whole. We use the name “Olsen Twins” but we also know these ladies as Mary-Kate Olsen and Ashley Olsen.

That is all you need to know about accounting, if you can get your head around that one concept you are all sorted, so make sure you have it clear in your head….

Example
a) you make a sale and then bank the money – By recording both the value of sales and the change to the bank you are doubling your work (you could just track the bank), but by tracking both where the money went, AND how much you have left you are also creating the ability to cross-check your own work and find mistakes and typos.
b) you pay the rent and your bank balance decreases – you record both what happened you paid some rent which shows on the Profit and Loss report; and the result the bank balance decreases which shows on the Balance sheet as owning less money.
In simple terms, for changes to the Profit and Loss report there are also a corresponding effects on the Balance Sheet. The concept is simply a process of record keeping – nothing tricky or magical.

cut through financial jargon image

TIP: The “Double” in double entry bookkeeping means – for every money transaction that goes in or out, it had a corresponding effect on what was owned or owed and vica verca.
You can also think of Debits and Credits as just like Newton’s 3rd Law – “for every action there is an equal and opposite re-action”, the same as with a see-saw.

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To Recap:

THE PROFIT AND LOSS REPORT (Also called an Income Statement ) gives a history – it records all the “IN and OUTs” of a business – sales are “Ins” and expenses are “Outs”. Income Statements are always displayed to show activity over a period of time, a week, a month, a year – It is telling a story “between this date and that date this is what has happened…”

THE BALANCE SHEET (Also called a Statement of Financial Position) – gives a snapshot – after selling goods and operating a business for a while, it ends up with whatever is left over. Balance Sheets are displayed at a fixed point in time– this report balances up the things owned with what is owed; preferably showing the scales are tipping favourably.

As a business owner you can ALWAYS avoid Debits and Credits

Unless you are a bookkeeper or an accountant, the mechanisms of the accounting process are unnecessary to understand, and even so with the new fancy software many bookkeepers are not fluent in using journals, debits and credits because the program does it for them.

On the other hand financial reports should be understandable, relevant, reliable and comparable, which is how accounting standards and conventions came about – being consistent in classification and treatment enabled business owners to review and analyse their results across various years seeing what worked and what didn’t, and making decisions on how to improve moving forward.

Tip: For making more profit what is important is reading the outcomes of the Debits and Credits, not understanding their processes.
Knowing what is in your Profit and Loss and Balance Sheet Reports and making sure things are on track (or being able to identify and fix them fast if they go off track).

Avoid the debits and credits, leave that to the bean counters, and embrace your Financial Reports as the best tools for making more profitable decisions – go ahead and embrace your own financial expert within!

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2016-12-20T13:08:50+00:00