A Business Owner’s Guide to Double-Entry Accounting

This excerpt was originally published in full on ScaleFactor’s blog.
Graphics by Lin Zagorski Latimer.

As a business owner, you’ve navigated your way through tough challenges and taught yourself some new skills as you figure out each area of your business. We’ll admit that accounting can be a bit of a black hole for business owners—you don’t want to be an accountant, but you do want to have enough accounting know-how to run your business successfully. But suddenly, two hours have passed and you’re no closer to understanding when to debit and when to credit. 

Like being a kid at school, you might wonder when you’re ever going to use this stuff. 

Double-entry accounting is a lot like learning multiplication. Understanding how to do it will equip you for all sorts of business challenges, specifically like how to read your financial statements with confidence and make thoughtful financial decisions. But just like there’s little benefit to knowing what 456 x 1,920 equals off the top of your head, there’s little benefit to knowing every last rule to double-entry bookkeeping.  

With that in mind, we promise not to overcomplicate this. 

What is Bookkeeping?

Before diving into the double-entry system, let’s back up a step and define bookkeeping as a whole. 

Bookkeeping [Book k-kee ping] noun: The act of recording and organizing information relating to the financial transactions of a business.

In essence, when your business makes or spends money, you need to track it. There are some very specific rules for how to do that tracking, which we’ll begin to explore here. (If you’re interested in diving deeper into those rules now, check out this post on the Generally Accepted Accounting Principles.) 

What is Double-Entry Bookkeeping? 

There are two styles of bookkeeping: single-entry and double-entry. We’ll go into the differences between them, but for now, know this: the overwhelming majority of businesses will use the double-entry system. 

If you’re a new business or a very small business, you might use single-entry bookkeeping to manage your transaction data. However, if your business finances have complexities like accounts receivable or accounts payable, you’ll likely default to double-entry bookkeeping. And if you’re using accounting software of any sort, that software will automatically run on the double-entry system. 

A Brief Reminder: Accrual vs. Cash

When many people think of techniques for handling their accounting, they often think of cash basis accounting and accrual basis accounting. 

Here’s a quick rundown of the difference: 

• Cash accounting recognizes revenue and expenses in your books when money changes hands.

• Accrual accounting recognizes revenue and expenses when they’re incurred (or fulfilled), regardless of whether money changed hands yet.

The difference in these two accounting methods, as you can see, has to do with when money is recognized in your books. If you send invoices or pay bills at later dates, you’ll likely lean toward the accrual method.

But if you’re following the rules of either cash or accrual accounting, you’ll still use double-entry bookkeeping. Single-entry bookkeeping is really only reserved for businesses that are so simple, they can manage everything in a straightforward Excel spreadsheet.

Single-Entry vs. Double-Entry: What’s The Difference? 

The overall complexity of your business will help dictate whether you manage your books using the single-entry or double-entry bookkeeping method. But let’s get down to brass tacks. 

What’s really different between these two methods? What do you do when you open your accounting file?  

The biggest difference is that single-entry accounting could be done in a simple spreadsheet. It’s similar to balancing a checkbook. For your columns, you’ll have the date, as well as a column for income and one for expenses. When you earn money, you’ll mark the date and add the amount to the income column. Vice versa when you spend it. 

Single-Entry Excel Bookkeeping

In single-entry bookkeeping, here’s no general ledger or complex chart of accounts, which can certainly seem appealing. The down side, however, is that you learn very little from this system. If you want to know how much money you’re expected to bring in or what bills you have coming up, you’re out of luck. Likewise, if you’ve been paying down a loan, you have no way of seeing how you still owe by looking at your books. 

The double-entry system gives you a much more detailed view of your finances, and it does this through debits and credits. We’ll dive into them a little more below. For now, know that every transaction should be recorded at least twice—once as a debit and once as a credit. Every debit amount should have an equal credit amount. 

When you categorize a transaction in your accounting system, this should happen more or less automatically, but we’ll give you some back story of how it was once done by hand. 

A Brief Aside: The History of Ledgers

When finance professionals began writing down transactions, they’d have several different books, known as ledgers. They’d have a ledger for every type of transaction, like a one for cash, accounts receivable, expenses, inventory, etc. Throughout the month, they would write down the debits and credits affecting certain accounts in their individual ledgers. At the end of the month, they’d tally up all the debits and credits in each ledger and add the balance to the general ledger. 

The general ledger is the master ledger. It’s basically a summary of all the accounts in your chart of accounts (or all the types of ledgers you have). If you wanted the biggest of big-picture views of your business, you would turn to your general ledger.

Even though the world of accounting has evolved beyond the use of physical ledgers and writing down debits and credits by hand, finance professionals continue to use the same jargon to apply to the different parts of the bookkeeping process (which is why we included this brief aside).

So when you log into your accounting system, you might classify a transaction as an ”Office Supply” payment. But behind the scenes, your software should know to debit your Cash account and credit your Office Supplies expense account. 

Doing so allows you to see not only the bottom line of how much money you made or lost, but it also shows you the other areas of your business that were impacted as a direct result of that transaction. Every financial transaction impacts something else. If you spend money, you lose cash but (presumably) gain something in return. If you earn it, you’ve got cash in your pocket but you likely lost some inventory.

It’s easy to get hung up on the rules of double-entry accounting, but you can get past that by recognizing that it has a push-and-pull nature.