The Meaning of Balanced Books

If you think balancing your books is simply the process of recording money received from customers and payments of business expenditures, you’re perpetuating a charade upon yourself. Accounting that isn’t truly balanced is less than useless; it’s a pathway to self-destruction by making bad choices based on fictitious data. Without resorting to full command of accounting principles, you can understand the key elements of balanced books that are crucial to knowledgeable business management.

The Challenge

Grasping the meaning of debits and credits creates imagined horrors in the minds of most people. An easier to comprehend matter is the generality that accounting consists of a double-entry method. That is, every transaction has a combination of debits and credits. Think of transactions as posted to a general ledger comprising all the company’s accounts. Debits to some accounts are always equal to credits for other accounts.

Appreciating the double-entry concept permits you to realize the impossibility of merely adding an expense or removing an asset from the books. Such directives beg for the equal offsetting components of the arrangements.

Climbing the Mountain

The general ledger has five main types of accounts – assets, liabilities, equity, revenues, and expenses. Each account category has specific rules for the impact of debits and credits. A debit will increase the amount in some account types and decrease the total of other types. Knowing the difference is the product of an evolutionary process. Entrepreneurs who conquer this basic precept of accounting achieve synthesis of their financial records with optimal decision-making.

Thinking in terms of debits and credits is superior to referencing increases and decreases. A given transaction, for instance, may consist entirely of increases. That happens when all the account types affected get higher amounts by both the debits and credits. The accounts are simply on opposite sides of the Balance Sheet financial statement. Meanwhile, another transaction may comprise all decreases.

Reaching the Summit

The rule for asset and expense accounts is that they are increased with debits. Every time you incur a cost of doing business, one of your expense accounts increases. This is realized by a debit. When an enterprise acquires equipment or deposits money in the bank, an asset is increased. These results are accomplished with debits to asset accounts.

A different rule applies to liability, equity, and revenue accounts. Those types are increased with credits. Borrowing money, contributing owner capital, or making a sale adds to these accounts. Credits record those additions.

Take as an example a $500 sale and resulting deposit at your bank. Revenue increases but so does your bank balance. The books record a $500 credit to a revenue account and a $500 debit to the bank asset account. Circumstances are little more complex when you buy a $700 computer with the company credit card. You’ve increased your equipment assets as well as your credit card liability. The books have a $700 debit to the equipment account and a $700 credit to the credit card account. Master these basic bookkeeping steps and you begin to visualize the purpose and usefulness of balanced books.

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