Unless your business deals strictly with cash transactions, you’ll use double-entry bookkeeping. In double-entry bookkeeping, every transaction you record will involve at least two accounts.
Double-entry bookkeeping helps you keep track of asset and liability accounts and allows you to prepare financial statements and records (like your balance sheet, income statement, and cash flow statement) directly from your general ledger. The idea behind double-entry bookkeeping is to always be balanced, so your books comply with the accounting equation:
Credits and Debits
Using double-entry bookkeeping, you’ll record each transaction in at least two separate accounts – you’ll debit one account and credit the other. Record debits on the left side and credits on the right side. Your debits for one transaction must equal your credits for the same transaction.
For each transaction, the first entry is the account that will be debited, and the second entry is the account that will be credited. The second entry will be indented slightly to easily distinguish it from the first entry.
Chart of Accounts
When you’re setting up your company’s books, you’ll create a chart of accounts, which details each account your company uses. Typically, each account falls into one of four categories: assets, liabilities and owners’ equity, expenses, and revenue.
Your asset accounts can include inventory, accounts receivable, fixed assets – such as equipment or land, and cash. A debit to an asset account will increase the account, and a credit will decrease it.
Liability & Owners’ Equity Accounts
Your liability and owners’ equity accounts can include accounts payable, accruals, and bonds payable. A debit to a liability or owners’ account will decrease the account, and a credit will increase the account.
Your expense accounts, which will probably be your longest list of accounts, can include advertising expenses, office supplies, and payroll taxes. A debit to an expense account will increase the account, and a credit will decrease it.
Your revenue accounts will include income from cash and credit sales. A debit to a revenue account will decrease the account, and a credit will increase it.
If you buy inventory with cash for $5,000, debit your inventory account and credit your cash account. Your inventory account will increase, while your cash account will decrease.
If you buy $2,500 worth of inventory on credit, debit your inventory account and credit your accounts payable. Both accounts will increase.
If you pay one of your suppliers $1,000 toward a loan, debit accounts payable and credit your cash account. Both accounts will decrease.
If you purchase $200 worth of office supplies with cash, debit your office supplies expense account and credit your cash account. Your office supplies expense account will increase, and your cash account will decrease.
If you sold $1,500 worth of product in cash, debit your cash account and credit your cash sales revenue account. Both accounts will increase.