Before computers and software, we did all of our accounting by hand. Any accounting records were kept in large binders with reams of paper on file. Fortunately, accounting has gone digital, and as a small business owner, you can automate your financial transactions with accounting software like QuickBooks.
Financial statements like income statements, balance sheets, and cash flow statements are the most well-known types of statements. They show the financial health of a business. All three statements stem from basic bookkeeping — recording everyday business transactions that take place in an organization. This is where the general ledger comes in.
In financial accounting, the main accounting record of a company is a general ledger. Although there are software and tools that automatically categorize these transactions, it’s still important to know the basic components of general ledger accounts so you can spot potential issues.
What is a general ledger?
A general ledger is a record-keeping system used to sort, store, and summarize a company’s financial transactions. The ledger has a description of the transaction with a debit balance column and a credit balance column. The debit and credit account balance columns should be equal at the end of every reporting period (usually the end of the month).
A trial balance is designed to ensure the entries in a company’s bookkeeping system are mathematically correct in double-entry bookkeeping. For instance, if a business purchases a car on credit for $5,000, then the debit transaction is $5,000. But the credit transaction will also be $5,000 because it’s an account payable or money owed. So the balance would be $0.
The double-entry here would be a debit transaction as well as a credit transaction. However, a general ledger provides you with more detailed information split into five different categories.
These categories provide a much better picture of the health of your business.
Five categories of a general ledger
A general ledger is divided into five main categories that include assets, liabilities, owners’ equity, revenue, and expenses. These categories contain all accounting data that is pulled from a company’s different sub-ledgers, such as accounts payable (money that a business owes) and accounts receivable (money that is due to the business). The general ledger continues to record the amount of money credited and debited on a constant basis.
Here are the five different categories a general ledger tracks to help you set up your financial statements.
Assets are any resources with an economic value that a business owns with the expectation that it would provide a benefit in the future. Assets can include cash, inventory, property, equipment, trademarks, and patents.
Liabilities is an obligation that is owed to another business or individual. Examples of liabilities can include employee payroll, debt from bank loans, lines of credit, and mortgages or leases.
3. Owners’ equity
Equity is the difference between the value of the assets and the liabilities of the business. It’s not a great sign if the business has more liabilities than assets because it results in negative equity and is a signal of unprofitability. Essentially, there is more debt than assets, so your business is losing money.
Equity includes common stock or stock options for the business owners and shareholders. The values of common stock and stock options grow over time as business operations and profitability grow, thereby increasing the value of the business. This category shows you how much capital your business has available for activities like investing. Think of this like a balance in a bank account that shows how much wealth the owners have stored in the company. .
Revenue is the income of a business resulting from the sale of a good or service. Revenue includes sales, interest, royalties, or any other fees that the business collects from its customer base.
Expenses are usually incurred as a cost of doing business paid in exchange for a good or service. Rent and utilities are all examples of classic expenses.
The general ledger usually includes a front page that lists the names of the accounts that will be shown in the document known as the chart of accounts. The documentation of one account within the general ledger is referred to as an “account ledger.”
What are sub-ledgers?
Sub-ledgers within each account provide the detailed information behind each of the entries documented in account ledgers. Each transaction shows if they are either debited or credited, and if it’s classified as accounts payable, accounts receivable, and so on.
How does a general ledger work?
Double-entry bookkeeping is the concept that every accounting transaction has two effects on a company’s finances. The double-entry system is the most used type of bookkeeping because it helps generate a company’s balance sheet, made up of assets, liabilities, and equity.
Double-entry transactions, also called journal entries, have two sides to each transaction and are posted in two columns, reflected in the general ledger. For instance, if a company makes a sale, its revenue increases and its cash increases by an equal amount.
If a company borrows funds from a lender, the cash balance increases, but the company’s debt balance increases by the same amount. Fundamentally, double-entry bookkeeping follows this equation:
Assets = Liabilities + Owners’ Equity
This equation is consequently the formula for a balance sheet, where it shows a detailed breakdown of assets, liabilities, and owners’ equity. In bookkeeping, the balancing rule always applies, and the general ledger ensures your financial records are always balanced. If they’re not balanced, then you made a financial error that the information in the general ledger can now help you track down.
What information does a general ledger tell you?
The details contained in the general ledger are compiled, added, and summarized to produce income statements, balance sheets, cash flow statements, and many other financial reports.
What this does is help accountants, managers, and investors learn more about the company’s performance. If your accountant prepares a financial statement, and you, as a business owner, notice a sudden rise in expense accounts affecting your revenue or profits, then you will need to perform a more detailed investigation into the general ledger to see how those expenses added up.
If there are accounting errors, then it becomes even more necessary to dig into the general ledger and look at each recorded transaction to find out where and when the issue occurred. This may be cumbersome, but it’s vital for maintaining error-free and reliable financial reports so that you can make stronger business decisions.
How Can I Get The Most Out of My General Ledger?
To get the most out of your general ledger (and all other reports), set up the company’s structure properly. Hire someone with accounting experience, or learn how to set up the chart of accounts and classifications for your company’s accounting system.
Creating the right structure in your accounting system means you can track sales and costs of specific products. You can also track services or projects, and the cost of goods sold. And you’ll be able to track inventory and vendors, as well as monitor anything else that’s important to help you make good decisions.
Better yet, you can work with an experienced QuickBooks Pro Advisor specialized in your industry to help you manage your company’s financial operations.
QuickBooks intuitive accounting software helps provide a comprehensive audit trail so if you’re ever audited, you won’t have to dig through mounds of paper or files to get organized. You can just pull your general ledger report, click on a specific account, and print out the detail from that account with its relevant attachments.