Credits and Debits

Definition

In accounting, debits and credits are the building blocks for recording transactions, balancing what a business owns and owes. Here’s how they generally work: a debit entry usually means money or value is coming into an account, while a credit means money or value is leaving an account.

When you record a transaction, debits go on the left side of a ledger, increasing assets and expenses. Credits go on the right side, increasing liabilities and equity while decreasing assets and expenses. So, if a business buys a new piece of equipment, you’d debit (increase) the asset account and credit (decrease) cash or liability if the purchase is financed.

The main rule of thumb is that every debit must have an equal credit, ensuring the accounting equation stays balanced. This is the essence of double-entry bookkeeping, which keeps financial records accurate and complete over time.

Why it matters

Debits and credits form the foundation of accurate accounting. Every transaction is recorded in two parts—a debit and a credit—which balances the business’s financial records and provides a clear view of its assets, liabilities, and equity. This ensures that financial statements, like the balance sheet and income statement, correctly represent the business’s financial health.

By balancing debits and credits, companies can easily spot discrepancies and monitor profitability. If the books don’t balance, it signals an issue that could impact everything from cash flow management to tax reporting.