Is there a rationale for believing debit balances are favorable and credit balances are unfavorable?

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Michael Ugulini | (Level 3) Educator

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Both have their place on a business balance sheet as indications of how a company is managing their enterprise.

For example, "Accounts Receivable" is an indication of money owed to a business for sales made on credit. It is an indication of a company actually selling their goods or services and expecting future revenue from these sales.

However, most businesses will have "Accounts Payable" as well. These are payments they will owe for Inventory purchased on credit as an example, among other types of Payables. This is not necessarily a bad thing. A business needs to pay for Inventory, pay Taxes, pay for Heat, Hydro, Water and more. They will not always make upfront cash payments for their payables.

The key for a business is to have more Current Assets than Current Liabilities. If they don't, then they do not have enough Working Capital to run their enterprise.

A good way to check Working Capital is to figure out the Current Ratio. This is a financial ratio; it illustrates the proportion of current assets to current liabilities. Current Assets of $500,00 dollars and Current Liabilities of $250,000 means a Current Ratio of 2:1. You want more than a 1:1 Current Ratio in favor of Current Assets.

Remember though, having enough Cash on hand is extremely important to a business. They need cold hard cash for daily operations. It will take some time for Accounts Receivables to be collected. In fact, typically a small portion of Accounts Receivable are never collected and become Bad Debts. It's vital for a business to have sufficient cash on hand as it waits for the Payments owed to them to arrive each week.

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