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Understanding general ledger: Your financial foundation

Understanding general ledger: Your financial foundation

Now that accounting has embraced digitization, more business owners are keeping accounting records in software rather than in large binders stuffed with paper files. But to manage one’s business successfully requires more than modern technology: Both business owners and accountants need to know how the general ledger works to determine the company’s overall financial health.

What is a general ledger? 

The general ledger (GL) summarizes all the financial information pertaining to your business. In short, it provides a record of all your company’s transactions.

A fair share of your financial data is organized in the general ledger and a lot of it is kept in the sub-ledger. This helps you review the information quickly, identify inconsistencies, and use the data in the ledger and sub-ledgers to efficiently populate your business’s financial statements.

What does a general ledger tell you?  

The general ledger serves as a summary of transaction details for preparing financial statements (income statement, balance sheet, and statement of cash flows), providing an overview of company financial performance and liquidity.

General ledger format

The general ledger follows the “T format,” sometimes referred to as “T-accounts,” with the left side depicting debit and right side credit.

Typically, all transactions are initially recorded in the general journal, and then all the related accounts are transferred to the general ledger.

These are the main components you can find in the general journal:

  1. Journal entry: An entry number posted to each account along with the date
  2. Description: A brief description of the accounting data, and
  3. A debit and credit column: Each journal entry posts to both these columns.

General ledger example

To see how the general ledger works in practice, let’s take a closer look at Crumbs Bakery and their financial transactions.

  • On 1 January 2022, Crumbs Bakery purchased inventory for $12,000. 
  • On 5 January 2022, Crumbs Bakery made sales on cash for $5,500, in which the cost of the goods sold was $1,000. 
  • On 7 January 2022, Crumbs Bakery made $4,500 more sales on cash, in which the cost of the goods sold was $1,000.

All the above-mentioned transactions would be showcased like this in the general journal:

An example general ledger

These transactions would then be passed on to the general ledger as depicted below:

Another example general ledger

As seen in the example above, all the information in the general ledger is provided in a summarized format.

All financial statements like the income statement, balance sheet, and cash flow statement all draw upon the transaction records found in the general ledger.

General ledger vs. trial balance

Companies will also summarize the transactions posted in a general ledger account to create an internal financial report known as the trial balance. A trial balance contains two columns: Debit and credit.

If the debit and credit balances at the end of the worksheet are the same, that means there aren’t any mathematical errors in the ledgers.

However, there is always the chance that something gets misreported—like if you’re paying with petty cash and don’t record a $5 purchase. If that’s the case, your numbers may still add up but be inaccurate.

What are sub-ledgers?

A sub-ledger gives you a place outside of the general ledger to record detailed information on your transactions.

Basically, where your general ledger contains the summary-level information, the sub-ledgers contain the details, such as transaction dates, amounts paid, and descriptive information.

Sub-ledger accounts focus on specific areas of your business, such as customer accounts, vendor accounts, and fixed asset accounts, yet they still correspond with the general ledger—the total amount of a sub-ledger account will match the line item for that account in the general ledger.

Sub-ledgers are particularly helpful for businesses with a high sales volume because you can segment your financial transactions into digestible categories, making managing your financial data easier.

Some of the most common sub-ledger accounts are:

  • Accounts receivable: Money owed to your business
  • Accounts payable: Money your business owes
  • Cash: Liquid assets your company owns, including the owners’ equity account
  • Inventory: Sales or purchases that impact your inventory

But the kind of sub-ledger accounts you use depends on your company. Your bookkeeper needs to set up your accounting books using the most suitable sub-ledgers for you.

In addition to the general ledger, which is a record of all your financial transactions, your chart of accounts provides a list of all the account names and the related purpose for all your sub-ledgers.

General journal vs. general ledger

The general journal records transactions chronologically. This is where your accountant makes the original entry for your financial transactions and dates them. All transaction data comes to the general journal and makes its way to the general ledger.

Think of the general journal as the place to record all your raw transaction data, which then gets posted to the appropriate accounts, such as your accounts receivable and cash transactions. The general journal is a great place to find out when accounting transactions happen.

Why every business needs a general ledger

With the help of a general ledger, you can better track and evaluate every transaction for your business. But of course, that’s easier said than done—which is why we’ve drawn out exactly how general ledgers can be used to your benefit.

Reason #1: It’s how you get accurate financial statements

Thanks to the neatly summarized data in the general ledger, BILL’s AP automation software. The general ledger paints a clear financial picture of your company with profitability, liquidity, liabilities—you name it—all to help you better manage your finances.

Reason #2: It’s how tax returns are made easy 

Your accountant (or you as a business owner) will need to rely on the general ledger to file taxes. Since all expenses and revenue are in a single place and all transactional data is detailed in the sub-ledger, you can cut your filing time in half.

For example, if you are a small business owner and need to file Form 1099 for a contractor you hired this year, then you need to know how much you paid them during the year. In this case, you can quickly check the payment invoices recorded in the general ledger to fill out this form correctly.

Reason #3: It helps you prevent fraudulent activities 

Since the general ledger is an overview of every financial transaction, it is easy to see every entry made and identify unusual activity. 

This means that you don’t need to look through bank statements, invoices, or credit statements for a specific transaction when you have the general ledger at your disposal. With the help of this single-view-pane of all transactions, you can detect potential fraud quickly and take action immediately.

Types of general ledger accounts 

The general ledger accounts are typically divided into five fundamental categories within a chart of accounts. These five master accounts are the basis for all accounting systems: assets, liabilities, equity, revenue, and expenses. Let’s take a closer look at each general ledger account.

Balance sheet accounts

Balance sheet accounts are known to be permanent accounts. The reported balance in these accounts is carried over to the next period. All balance sheet accounts include assets, liabilities, and equity.

  • Asset accounts: Assets are resources that have an economic value for the business. These can include cash, inventory, property, equipment, and patents. Assets can be tangible (like equipment) or intangible (like intellectual property).
  • Liabilities accounts: Liabilities are all financial obligations your business owes to another company or an individual. These can include loans payable to the bank, accrued expenses, leases, and employee payroll.
  • Equity accounts: Owner's equity refers to the owners’ claim to business assets. It represents the difference between total assets and total liabilities. For example, owner-invested capital would make its way to an equity account.

Profit loss accounts

Profit and loss accounts—or income statements—are known to be temporary accounts.

These accounts do not carry over to the next accounting period since they close at each month's end. The following month starts with a zero balance. Profit and loss accounts include revenue and expense accounts.

  • Revenue accounts: Revenue comes as a result of selling services or goods. Some examples include commission earned by the company, interest income, sales revenue, or any other fees your business might collect.
  • Expense accounts: Expenses are business costs, like rent payments, wages, and utilities. Expenses are further split into overhead and operating costs, which are broken down on the profit and loss statement.

How a general ledger works

General ledgers use the double-entry accounting method, with each transaction in the ledger recorded in two columns, one for debit and another for credit. As mentioned earlier, journal entries represent a good portion of entries in the general ledger.

The entire financial accounting process has four essential steps, one of which involves recording entries in the general ledger:

A diagram showing the steps to the accounting process

Step #1: Gather source documents 

The first thing you—or your accountant—must do is gather the accounting documents that are used to post corresponding entries. If you’re creating a general ledger for the month of May, then all receipts and invoices from May must be recorded to ensure there are no missing entries.

Step #2: Post journal entries

Each journal entry should have an account number, a date, a dollar amount, and a brief entry description. These detailed entries tell you the who, the what, the when, the where, and the why—leaving no room for confusion, thus creating clearer transaction explanations.

Step #3: Record entries in the general ledger

All the entries are then posted in the general ledger. Some companies use sheet software like Excel for this purpose, but it’s typically not efficient for bookkeeping. Instead, accounting software solves this because automation brings efficiency and simplicity to the process.

Step #4: Financial reporting

To produce all the necessary financial statements, your accountants create the trial balance, which lists each account and the current balance. And to ensure that your financial reports are correct, you can even use an adjusted trial balance to see all your financial transactions in one place.

Benefit from a solution that streamlines your accounting system

General ledgers are essential as they help you record all your financial transactions. But creating a manual one is a complex undertaking—and you’re more likely to make accounting errors without a reliable system in place.

Because it is a sub-ledger, accounts payable is an important part of your general ledger. Staying on top of accounts payable will make this portion of your accounting easier to manage. You can spend 50% less time on your accounts payable process with .* Learn more about BILL today.

*Based on a 2021 survey of over 2000 BILL customers.

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