Eli5 What does it mean to ‘balance the books’?
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Accounting is “double entry” meaning that every transaction has a “debit” side and a “credit” side that equal each other. The basic accounting equation is: Assets = Liabilities + Equity
The reason the equation always balances out is because every entry to the books must balance.
Here’s an example:
Your company has $100 and buys $100 of inventory: Debit Inventory $100 / Credit Cash $100
…then sells all of it for $150: Credit Inventory $100 / Debit Cost of Goods Sold $100 / Credit Sales $150 / Debit Cash $150
Each entry balanced (debits=credits), so your books are balanced. Back to the equation:
Assets (cash): $150
Liabilities: $0
Equity: $100 (the original $100 you had in your account)
Income: $150
Expenses: $100
At the end of the period, you move net income to equity, so the $50 in net income is added to the $100 beginning equity, and now
Assets ($150) = Liabilities ($0) + Equity ($150)
Perfectly balanced.
The other way to look at it is what is called a “Trial Balance” – the TB lists every account on the ledger, and the balance in each account is either a Debit (expressed as a positve number) or Credit (expressed as a negative number), and if you add them all up, you get zero.
From the example:
Cash 150
Equity (100)
Income (150)
Expenses 100
Balance 0
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