Remember learning punctuation in grammar school? If you were like me you didn’t understand what the big deal was—like, who cares, right? In hindsight, probably not our proudest educational moment; alas, we understand that punctuation is an essential part of communicating with language. Since most of my friends eyes glaze over like a redneck in a foreign film theatre when I talk about finance, I know that finance has a language unto itself. To learn that language it helps to begin some of its most basic concepts: debit and credits.
You’ve read this far so I guess now I can let you know that you got here under false pretenses. I have to explain Double Entry Bookkeeping in order to fully flush out debits and credits. Sorry I snuck that one in here.
Double Entry Bookkeeping
In double entry bookkeeping two entries are made for every single transaction. Think about it: money has to move from one place to another, so it makes sense that it would require two entries. It’s these entries that are called either a debit or credit.
In business, a debit is an increase to expenses and a decrease to revenue, and a credit is a decrease to expenses and an increase to revenue. Read that again. The trick to knowing which is what is to identify the two components of a transaction: which is the debit, and which is the credit?
Debits and Credits
If I transfer money from my checking account to yours, I am debiting my account and crediting yours (two entries, one transaction). So you know that in this case, a debit is a decrease, while a credit is an increase (now you know how a debit card got its name). For most people, this is as simple as it need be, but humor me.
Let’s now think about a paycheck, and then a single purchase made with the paycheck. Think of your entire paycheck as revenue because in the business of your life it is. Taxes would then be debits on your paycheck because they work to reduce your revenue. Let’s say your employer pays you a non-salary bonus (because nothing has caught fire recently), that would be an increase in revenue and thus a credit. Let’s move on from that transaction: feeling good because of your bonus you go out and buy a pair of Dutch wooden clogs. The cost of these shoes would be a debit to your checking account because it’s an increase in expense. Oh no! The clogs broke (now you know why they went out of style), so you return them—the money you get back would be a credit to your account.
The concept of debits and credits is linked arm and arm with that of double entry bookkeeping. In day to day life it’s probably hard to imagine thinking about things specifically in that light—you probably won’t. But try to take the general concept (two entries, a debit and a credit, for every single transaction) and apply it to the peripheral financial concepts you will learn on this site; to perhaps some of the most important transactions you make regularly. After a while you will be using the terms fluently, I promise you. As for my friends; well, they might as well start growing mullets.
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