As a busy business owner, you may not have much interest in basic accounting principles, such as maintaining a general ledger. While most accounting activities are best left to your accountant, it can be helpful to understand what a general ledger is and how it works.
Maintaining a general ledger is one of the best ways to gauge your business’s overall financial health. It also helps ensure you’re not making any of the common business accounting mistakes that could cost you time and money down the road.
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What is a general ledger?
A general ledger is a record of a company’s financial transactions. General ledger accounting summarizes and sorts a company’s financial information. Most businesses track this information with accounting software.
A general ledger outlines each transaction that took place and sorts them by type. Companies use general ledger data to compile their financial statements.
A general ledger includes the following information:
- Revenue: Revenue is the cash earned from the sale of a company’s products or services. In accrual accounting, unlike cash accounting, companies must record revenue when it’s earned, not when it’s received.
- Expenses: Expenses are anything your business spends money on, including payroll, rent and marketing. A combination of fixed and variable expenses determines your business’s profitability.
- Assets: Business assets are anything of value your business owns. Asset ledgers typically have sub-accounts. The larger the company, the more complex the asset ledger will be.
- Liabilities: An accounting liability is anything your company owes. The liability account is where your company records things like debt, customer prepayments and deferred income taxes.
- Equity: Equity is the owner’s interest in a company’s assets. Calculate your equity by subtracting your company’s liabilities from its assets.
How is a general ledger used in accounting?
There are four primary components of a general ledger:
- Journal: The journal contains raw accounting entries, recorded sequentially by date.
- Description: Each transaction will include a brief description.
- Debit and credit columns: Every transaction in the general ledger will be labeled as either a debit or credit.
- Balance: Each time a new debit or credit is posted to the account, you’ll need to update the balance. This ensures your business’s financial records are up to date.
To get started, create a journal and record each business transaction as it occurs. Make sure each transaction is recorded with the correct account. Once your journal is completed, you’ll transfer this information to the general ledger.
A general ledger takes the information from a journal and categorizes it into the correct accounts. Each entry will also include sub-accounts, which break down the transaction even further.
For instance, if you were recording an asset, the sub-accounts might include savings, inventory or accounts receivable. Revenue sub-accounts could consist of product sales or miscellaneous income earned.
FYI: If you hire a bookkeeper for your business, maintaining a general ledger will be one of their primary duties, along with balancing the books, creating invoices and handling payroll.
General ledgers and double-entry bookkeeping
Double-entry bookkeeping is a concept stating that every financial transaction impacts a company’s finances in two different ways. The following equation summarizes it:
Liabilities + Equity = Assets
A company’s total assets must equal the sum of its liabilities and the owner’s equity in a double-entry system. A double-entry system ensures the balance sheet stays balanced every time and that each debit has a corresponding credit.
The critical thing to remember about double-entry bookkeeping is that every transaction affects at least two accounts. For example, let’s say a business takes out a loan for $500,000. That loan is considered a liability, but it also contributes to the company’s total assets. Or, if a business purchases inventory, that inventory raises its assets while also taking away from its cash.
Double-entry bookkeeping ensures that the business maintains accurate records with a corresponding relationship between each liability and asset.
How do businesses use general ledgers?
Businesses use general ledgers as part of the accounting process. Without a detailed general ledger, your accounting can quickly become disorganized and inaccurate. Inaccurate financial records cause significant problems down the road.
A general ledger provides the information necessary to create a balance sheet or cash flow statement. It also gives you a quick overview of your organization’s financial health.
For instance, if your business applied for a PPP loan in 2020, you probably used the information in your general ledger to create financial statements for your bank. A general ledger also creates a comprehensive audit trail, which will be helpful if you ever get audited.
Did you know? The IRS averages about 300,000 audits per year, so your chances of being audited are relatively low. To reduce your chances further, learn the ways to keep your small business from being audited.
What do general ledgers tell you?
General ledgers help you generate financial statements for financial institutions or stakeholders. They can also help you better understand and track your business’s finances. Here are a few ways they do this:
They prepare a trial balance.
Preparing trial balance means adding up your debits and credits to ensure that both columns match. This ensures your books are accurate and that there are no mathematical errors. Most companies prepare a trial balance at the end of each reporting period.
They provide an overview of your business finances.
A general ledger gives an overview of your business’s financial activity. It allows you to look more closely at your finances over a specific time period. For instance, you can review your financial activity over the past year or shorten the time frame to the past 90 days.
They make it easier to spot problems.
One of the most significant benefits of using a general ledger is that it becomes easier to spot financial problems in your business. For instance, if you notice that your expenses have been significantly higher over the past year, reviewing your general ledger can help you uncover why that is.
Bottom line: An accurate general ledger provides a valuable overview of your business finances and makes it easier to spot potential problems.
Example of a general ledger entry
Use a general ledger to record any financial transactions in your business. Here are some examples of what that would look like:
- Deposits to a checking or savings account
- Incoming revenue from product sales
- Recent inventory purchases
- Office supply orders
- Payroll checks
- Estimated quarterly state and federal tax payments
- Business insurance payments
Here is an example of what a general ledger entry would look like:
As you can see in this example, the inventory purchased affects both the debit and the credit columns.
How accounting software can help manage your general ledger
Most businesses use feature-rich accounting software to manage a general ledger. But not all accounting software will allow you to produce a general ledger report. If you’re looking for software that will, here are some of the best options:
- QuickBooks: QuickBooks is all-in-one bookkeeping software, and the desktop version will run a general ledger report. The software makes it easy to automate payroll and batch transactions, and to run trial balances. That’s why it’s our pick as the best accounting software for small businesses. Read our QuickBooks review for more information.
- FreshBooks: With FreshBooks, you can track your revenue and expenses and create a trial balance to ensure everything adds up. The reports you generate may not be as detailed as with other software, but FreshBooks will create a basic general ledger report. Learn more in our FreshBooks review.
- Wave: Wave is free to use, and it’s an excellent option for new or growing businesses. The software uses the double-entry system and makes it easy to generate financial reports come tax season. Our review of Wave has more information.
Tip: For a more in-depth exploration of accounting software and its features, check out our full reviews of the best accounting software.
What goes into a general ledger?
A general ledger is used to record and track a company’s financial transactions. The following transactions could be added to a general ledger:
- Income from product sales
- Cash spent on office equipment
- Quarterly tax payments
- Recent payroll expenses
What is the difference between a general ledger and a balance sheet?
A general ledger and a balance sheet keep track of similar information, but they aren’t the same thing. With a general ledger, you’ll record every transaction from the very first day you go into business.
A balance sheet doesn’t go into that level of detail. Instead, it provides a snapshot of a company’s financial health over a certain period of time. The primary purpose of a balance sheet is to provide an overview of the company’s assets and liabilities. For that reason, balance sheets are often used to determine whether a business meets the requirements to get approved for a small business loan.