Double Entry Accounting: What It Is and How It Works

How can companies keep their accounts balanced?

One of the best mechanisms that accountants utilize to obtain an authentic financial picture of a firm's finances is double-entry accounting. In other words, credits to one account need to be comparable to debits to another account to ensure the equation remains in balance. Credits are offset by debits.

By comparison, single-entry accounting will only track expenses and revenues.

It is popular because it shields a business from immense accounting errors that will lead to severe headaches in the future.

The Double Entry Accounting Equation

So, what is the double-entry accounting equation?

The formula is pretty simple:

Assets = Liabilities + Equity

Equity and liabilities may impact net assets, so both sides of the equation can affect the other side. This explains why each single transaction requires two accounts rather than one.

How Double Entry Accounting Works

As previously mentioned, double-entry accounting works by having every transaction jotted down as two accounts: a debit to one account and a credit to another.

Let's say, for example, a company takes out a $10,000 loan. Assets are debited $10,000 and liabilities are credited $10,000.

Or, as another instance, your business acquires a $1,000 new office laptop. The two entries would look like this: you are trading one asset (cash) for another asset (laptop). Therefore, you will need to insert cash and laptop accounts in your books.

Differences Between Single and Double Entry

The primary difference between single- and double-entry bookkeeping is that the former has one entry for each transaction and the latter has two.

Financial experts say that single-entry accounting can be used to calculate net income. However, it cannot be incorporated into accounting mechanisms since it is not possible to develop a balance sheet and track the asset and liability accounts.

The primary advantage of a single-entry system is that it is simplistic, and anyone without intimate knowledge of accounting can use this strategy. However, this also applies strict limitations on businesses because you cannot erect and monitor accounts payable, accounts receivable, and inventory.

Importance of Double Entry Bookkeeping for Ecommerce Stores

Now, there are many reasons why double-entry bookkeeping is critical, and here are a few:

Accuracy and Error Reduction

In accounting, and even just running a business in general, accuracy is paramount. From data entry to financial reporting, double-entry accounting is critical to success in the business world. Remember, the details, no matter how small, can make a big difference in the future.

How many times have errors led to substantial headaches for the company? Double-entry accounting greatly trims errors because it maintains a system of checks and balances. This is even better when you consider that many accounting software programs provide a double-entry feature. The system is not perfect, but it will reduce errors by an exceptional amount.

Everything Is Accounted For

Indeed, when you are engaged in double-entry bookkeeping, every little thing is accounted for in your ledger. Whether it is a business-related loan, purchase, or deposit, every type of transaction will be recorded in the books. Errors can always slip through the cracks, even when using an accounting service like QuickBooks. Companies (small ecommerce businesses especially) should do what they can to mitigate the risk, such as using an automated bookkeeping service to help manage your books accurately.

Company Status Overview

Double-entry accounting can provide you with a bill of health for your company. Is your business keeping the budgets balanced? How are income flows? Are you meeting financial requirements?

Ultimately, double-entry bookkeeping can offer a snapshot into your business' true financial health.

Audit Trail

Whether you want to reduce fraud or you want to make sure everything is prepared for a visit from the taxman, double-entry bookkeeping makes it easy to trace each transaction and ensure your balance sheet is accurate. Of course, it is also a good idea to have documentation to prove each transaction listed in your ledger.

Easier to Get Loans

Many ecommerce businesses—especially those who are just starting out and don't have much capital to play around with—will consider taking out a loan at some point. This can be difficult to do without an easily navigable balance sheet. Essentially, using double-entry bookkeeping can make it easier to get that much-needed loan.

Who Makes Use of Double-Entry Bookkeeping?

For the most part, small businesses that have more than one employee or are searching for additional funding will use double-entry bookkeeping.

The primary reason is that it is quite accurate and offers a complete picture of how the organization is performing and how fast (or slow) operations are expanding.

Of course, Businesses of all sizes, including small- and medium-sized businesses (SMBs), can benefit from double-entry accounting. Whether you're an established ecommerce seller or an emerging Shopify entrepreneur, you should definitely consider this type of accounting.