Understanding the term Credit in finance requires that you grasp the accounting perspective of the term. And in accounting, it is difficult to understand the term Credit without reference to a sister term: Debit. In strict accounting sense, Debit is actually the opposite of Credit. These two terms can be quite confusing when used outside the accounting world because they can be taken to mean very different things. That is why it is important to first look at them from an accounting perspective, because that is the basis of both corporate and personal finance. Your Personal Financial Mentor gives you an accounting perspective of the term Credit versus its sister term: Debit. You will find it easier to understand these terms from that angle as opposed to what you are accustomed to hearing.
In an organization, book keeping is inevitable. Every organization needs to have records which represent the transactions that take place in the organization. And when you prepare accounts for an organization or a business, there are two sides. To the left side, the entries are called Debits, while to the right side, the entries are called Credits. In basic accounting, such a record is referred to as a Balance sheet.
Anything that comes into the organization is recorded on the Debit side. For example, the organization’s capital is usually on the Debit side, and so are all cash from sales. Any inflow of cash is recorded as a Debit on an accounting Balance sheet. Therefore in business terms, Debit refers to inflow.
Credit, on the other sides, refers to something that comes out of the organization. For example, wages and salaries are recorded on the Credit side of a Balance sheet. Payments for supplies are also recorded on the Credit side, meaning that the organization makes the payment, whether in cash or not. In essence, therefore, Credit refers to the expenses of the organization, which in other words, means there is an outflow of money in the organization. Dividends given to shareholders are also recorded on the Credit side because they represent money that flows out of the organization.
The difference between the Credit side and Debit side is usually given as the balance of the accounting record, which is why the whole document is called a Balance sheet. If the balance is on the Debit side, then it means that the organization had more money coming in than money flowing out. Otherwise if the balance is on the Credit side, it means the organization incurred more cost than its income.