Public corporations are required to employ double-entry bookkeeping. It's the most impactful way to understand their financial operations and the basis for their outgoing financial reports.
Not all small businesses are required to use double-entry bookkeeping, but it's a very good idea to do so. Putting it into practice can help a small business get control over its expenses and revenue, helping it pinpoint issues with everything from cash flow and income to inventory and over-spending.
The concept is simple — although for it to work correctly, double-entry accounting must be followed to the letter.
What is Double-Entry Bookkeeping?
Double-entry bookkeeping is founded on a very simple principle: Every accounting entry incurs a debit and a credit. When you buy a piece of equipment, you earn a piece of inventory, but you lose cash. Conversely, when you sell a piece of equipment, you gain cash and lose inventory.
The point of double-entry bookkeeping is to give you a more complete view of your company’s financial activity. Every transaction recorded on your general ledger needs to account for an equal amount of debit and credit.
When double-entry bookkeeping is done successfully, your total debits and total credits are the same number.
Principles of Double-Entry Accounting
The core of double-entry accounting is one simple equation: assets = liability + equity.
Assets are everything in your company’s possession. They include physical assets like inventory, buildings, machines, furniture — whatever you have on hand. It also includes cash and intangibles, such as patents.
Your overall liability is comprised of everything your company owes. It includes short-term payment that’s still due on a recent equipment purchase or promissory notes for loans to banks.
Equity, in terms of small business, represents the company’s profits or losses, combined with the contributions the owners have made to it. It’s ownership's total stake in the company.
Double-entry accounting revolves around the notion that all your company's liabilities are offset by what it holds in equity. That's expressed when debits and credits are equal in the final accounting. If the numbers are off, then something's amiss.
How is Double-Entry Bookkeeping Recorded?
Your general ledger has two columns for every transaction you record: debit on the left, credit on the right. For each transaction, you record the exact amount involved twice, once in each column, to indicate what expense accounts were debited and credited in the exchange.
Here are some double-entry bookkeeping examples:
Your cleaning product company purchases three new laptops on credit for a total of €3,500. You’ve obtained new equipment, but you’ve added to the amount you owe your creditors. The double entry might look something like this: