What is a credit?
Definition of a credit
A credit is an entry in your accounts that reduces what you own or increases your profit. It's the opposite of a debit entry.
How credits work in your accounts
There are five different kinds of nominal accounts in a business, and a credit affects each account differently.
- it increases a liability that your business owes, such as a bill from your supplier
- it increases income that your business is earning, such as an invoice you give to a customer
- it increases capital (or money) that the business owes back to its owner
- it reduces an asset that your business owns, like its cash
- it reduces a day-to-day running cost or expense of your business, like its accountancy fees
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Every time you make a credit entry in a set of accounts, you must also make an equal and opposite debit at the same time.
How debits and credits work for different accounts
To increase the amount in your business accounts, you need to debit some accounts and credit others. What you do depends on the kind of account you’re dealing with:
- for an income account, you credit to increase it and debit to decrease it
- for an expense account, you debit to increase it, and credit to decrease it
- for an asset account, you debit to increase it and credit to decrease it
- for a liability account you credit to increase it and debit to decrease it
- for a capital account, you credit to increase it and debit to decrease it
Example of a credit:
When you run your payroll, you have to pay some money to both HMRC and your staff. These are liabilities in your accounts, so they will be credit entries in your balance sheet. Remember, every credit must also have an equal and opposite debit. The cost of the staff salaries is a day-to-day running cost, so is debited to your profit and loss account as an expense.
Frequently Asked Questions
Why doesn’t a credit always increase the amount of money? That’s how it works in my bank account!
On a bank statement, money paid in is labelled “Credit”, and money taken out as “Debit” because the bank are looking at this from their own point of view. For them, when you pay some money into the bank, that’s money that they will have to pay back to you sometime. So that’s increasing what they owe to you, which for them is an increase in a liability - and an increase in a liability is a credit.
And when you take money out of your bank account, that reduces the amount that they’ll have to pay back to you. That’s a decrease in a liability, which means that it's a debit.
Got questions? Ask Emily!
FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.