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, understanding what a general ledger is and how it works can be beneficial.
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 typical accounting mistakes that could cost you time and money down the road.
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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 financial accounting information with accounting software.
A general ledger outlines all transactions and sorts them by type. Companies use general ledger data to compile their financial statements.
A general ledger includes the following information:
There are four primary components of a general ledger:
To get started, create a journal and record each business transaction as it occurs. Ensure 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.
Double-entry bookkeeping states that every financial transaction impacts a company’s finances in two 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 the business maintains accurate records with a corresponding relationship between each liability and asset.
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. A general ledger creates a comprehensive audit trail, which will be helpful if you ever get audited by the IRS.
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.
Preparing a trial balance means adding debits and credits to ensure both columns match. This practice ensures your books are accurate and have no mathematical errors. Most companies prepare a trial balance at the end of each reporting period.
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 period. For example, you can review your financial activity over the past year or shorten the time frame to the past 90 days.
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 your expenses have been significantly higher over the past year, reviewing your general ledger can help you uncover why.
Use a general ledger to record your business’s financial transactions. Here are some examples of what that would look like:
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.
Most businesses use feature-rich accounting software to manage a general ledger. However, not all accounting software will let you produce a general ledger report. Here are some excellent accounting software options that support general ledger accounting:
A general ledger is used to record and track a company’s financial transactions. The following transactions could be added to a general ledger:
A general ledger records every transaction a business makes and serves as the basis of your financial reporting. You can use a general ledger to obtain more information about your company’s cash flow, purchases, assets and liabilities. A general ledger helps your accountant and other stakeholders assess how the business is performing.
A general ledger and a balance sheet track similar information, but they aren’t the same thing. With a general ledger, you’ll record every transaction from the 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. 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.
A general ledger tracks business transactions and relevant accounts. Most companies use a general ledger to create their financial statements. The general ledger is responsible for tracking the business’s expenses, liabilities, revenue, assets and capital.
In contrast, a general journal records a company’s business transactions. It often includes detailed information about each transaction and is used as a temporary record.