Let's explain what is double-entry accounting?
Double-entry accounting is based on the principle that a financial transaction recorded in one place as a credit (cash earned by your company) must elsewhere be recorded as a debit (cash lost by your company). Think of it as Newton's third law but applied to accounting: All transactions have an equal and opposite transaction. This can be represented by basic mathematical equation of accounting:
Assets = Liabilities + Equity
Double-entry accounting, despite not being a mandatory accounting method, is used by many small to midsize businesses. If the accountant you've hired for your company has included a credit and debit column in your general ledger, your company is likely already using double-entry accounting. You're also likely using double-entry accounting if cash isn't your company's only account and instead you have a chart of accounts that paints a complex, detailed picture of your company's finances.
Types of accounts
You may have noticed several different transactions in your ledgers such as cash from a customer to your company, cash value lost in inventory, and money borrowed from a creditor. In double-entry accounting, all transactions can be grouped into one of seven different types of accounts:
Assets: What your company owns, including cash, accounts receivables and equipments
Liabilities: What your company owes, including accounts payable and loans
Equities: The amount of your company's value tied up in shareholder stocks
Revenues: The amount of money your company earns from selling its products or services
Expenses: What your company spends to cover its operations, including rent, utilities and employee wages
Gains: what your company earns by selling an asset
Losses: what your company loses by selling an asset
Benefits of double-entry accounting
There are myriad reasons why most businesses use double-entry accounting. Among the benefits that accompany double-entry accounting are:
A thorough understanding of your finances. Since an amount recorded in one account is recorded in another account, double-entry accounting gives you a complete picture of your company's finances. If your cash flow is lacking, you'll see where your cash is tied up, be it accounts receivables or overspending on supplies.
Fewer accounting errors. Since double-entry accounting by definition requires the total value of all your accounts to equal zero, you'll know you have accounting errors if your total value isn't zero. Granted, finding the sources of these errors may take work, but in double-entry accounting, errors are usually less frequent, given the clear credit and debit columns in each of your accounts. Plus, under double-entry accounting, you'll know to always pair a transaction with an equal and opposite transaction elsewhere.
Easy conversion into financial statements. Through financial statements, you can quickly see your company's assets, liabilities, equity, cash flow, profit and many other metrics vital to your financial well-being. Double-entry accounting facilitates the creation of these statements, since the value of your company's accounts will always be apparent. And these statements are good for more than your own internal use: They are beneficial when you are seeking debt or equity financing.
More transparent finances. The credit-debit columns and numerous account types fundamental to double-entry accounting give a comprehensive view of your company's spending and earning. As such, your company's finances will be clear to you, your accounting team and any funding sources who ask for your financial statements.
The ability to hold yourself and your clients accountable. Double-entry accounting clearly indicates when your clients owe you money and when you owe money to employees or vendors. That means more accountable business practices for you and everyone you work with, since you'll know when to ask for money you're owed and pay other people.
It's the common standard. Most businesses including ibizz use double-entry accounting. Investors, banks and any parties you're working with toward a merger or acquisition may feel less inclined to work with your company if you use single-entry accounting.
- Double-entry refers to an accounting concept whereby assets = liabilities + owners' equity.
- In the double-entry system, transactions are recorded in terms of debits and credits.
- Double-entry bookkeeping was developed in the mercantile period of Europe to help rationalize commercial transactions and make trade more efficient.
- The emergence of double-entry has been linked to the birth of capitalism.