What is Double-Entry Bookkeeping and How Does It Work?
Maria Peloponisiou~ 5 min Reading time | 17. Sep 2019
For anyone new to accounting, keeping a record of accounts might sound simple—after all, if you can keep track of your bank account, you can keep track of your business income, right? Actually, most accounting systems are a lot more complex, using a double-entry bookkeeping system to keep track of a lot more than just the sum of money you have. If you want to know what your money management habits are—where your money is being spent, what your cash flow looks like, how much money is tied up in unpaid bills—double-entry accounting is for you.
A double-entry system enables you to generate reports like a balance sheet, income statement, and cash flow statement to help you see patterns in your business finances. While some businesses opt for single-entry systems, accounting software like Billomat uses a double-entry approach to enable you to see exactly what is happening with your money.
How Does Double-Entry Bookkeeping Work?
All accounting systems keep track of the total value of a business with a general ledger, or a system of numerical accounts that categorize everything a business owns, is owed and owes. For example, there are usually accounts for revenue, cash, inventory, equipment, loans, revenue, accounts receivable, and equity. This way, if you take out a loan to buy a computer for your business, the loan is recorded, as well as the increase in cash; the subsequent purchase of the computer is recorded as a decrease in cash and an increase in the equipment ledger. On your books, you’ll be able to see that your business has a new asset, but that you have a pending loan as well. If there’s extra cash leftover from the loan, double-entry bookkeeping makes it easy to spot where that cash came from.
Debits and Credits
Double-entry bookkeeping uses a system of debits and credits to keep track of the inflow and outflow of money in diﬀerent accounts. Debits always appear on the left of the accounting ledger, while credits appear on the right. But be careful—they aren’t debits and credits as you may normally think of them! In relation to our bank accounts, we normally think of credits as cash going in and debits as cash going out—however, in double-entry bookkeeping, debits and credits can be either one, depending on the account. Some accounts increase with debits and decrease with credits, while other accounts increase with credits and decrease with debits. This ultimately allows the accounting equation, Assets = Equity + Liabilities, to balance.
For example, Cash accounts are ledger accounts which increase with debits, while Revenue increases with credits. So when you make money from a sale, your cash account is debited and your revenue account is credited, even though they both increase!
When accounting is done manually, debits and credits are recorded in what is known as journal entries, so that there’s a record of each transaction and how accounts were debited and credited. In the previous section, we mentioned the example of taking out a small loan of £5,000 to purchase a computer. The table below shows how you’d represent this in a journal entry. Since Cash and Equipment are accounts which increase with debits and Notes Payable is an account which increases with credits, you’ll see that a loan increases both Notes Payable and Cash but that Cash is debited and Notes Payable is credited. When the purchase is made, Cash is credited and Equipment is debited.
Purchase of Computer
If you find this confusing, don’t worry—accounting software does this work behind the scenes, so you don’t have to manually make both entries. All you need to do is enter the information once, and the related accounts will automatically adjust.
Double-Entry vs. Single-Entry Bookkeeping
Whether or not to use double-entry bookkeeping depends on how you’re keeping records and how complex those records need to be. For example, banking information appears on your bill as a single-entry record—your bank statement. You can see money added to or subtracted from your account, with a total at the end. Small business owners who keep only paper records sometimes opt for single-entry bookkeeping because of its simplicity, but there are some significant drawbacks to this approach. For one, it’s easier for errors to go unnoticed, since each entry doesn’t need to match another one, so there’s nothing to check it against. Secondly, you can’t generate reports from single-entry accounting, so if you need an overview of your money management habits, it’s not as easy to get it. Single-entry bookkeeping is usually used in cases where someone is keeping track of their money manually, whereas accounting software will usually use double-entry bookkeeping.
Should I Use Double-Entry Bookkeeping?
Generally, it’s advisable to use a double-entry system unless your business is extremely small or just a hobby. Keep in mind that it can be complex to switch to double-entry bookkeeping after the fact if you opt for single-entry, so if you think your small business has the potential to grow quickly, it’s advisable to start with double-entry bookkeeping. If you are still unsure, it’s best to consult with an accountant to figure out what the best fit is for you.
Also keep in mind that, although it’s useful to have some knowledge of double-entry accounting, you don’t need to have a thorough understanding of it to use software that operates on this principle. In fact, software often makes double-entry accounting possible for those who aren’t accountants and don’t have the training to do it on their own. Software like Billomat will help you enter the raw data from your transactions and will do the double-entry accounting for you, so you’re left with all the reports you’d get using double-entry accounting with none of the hassles of actually having to do it! Check out Billomat’s 60-days free trial here >>>