It is easy to argue that the general ledger is one of the most essential components of any business’ finances. Put simply, a general ledger is a complete record of a company’s entire financial transaction history. Pretty important, right?
This record is made up of all the company’s accounts, or different reports that are used to sort and store transactions. While the general ledger has gone digital, it’s important to understand how it is used and maintained, particularly when it comes to understanding your business’ financial statements.
What Are the Components of a General Ledger?
The process of making a general ledger begins with recording every transaction your small business carries out and the details of each transaction in a journal entry. These transactions can then be categorized into their relative accounts. From there, you can transfer the records of these accounts into a single source—otherwise known as your general ledger. Below is a breakdown of the key components and the steps taken to create this document.
Double-Entry Bookkeeping Method
A general ledger operates under the idea of double-entry bookkeeping. This means that every financial transaction will be shown as both a debit and credit on the ledger. In the end, the sum of all debits on the general ledger should always equal the sum of all credits. If this is not the case, then it is considered out of balance.
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Debits and Credits
All transactions in a general ledger must be listed as a debit entry and a credit entry for the books to conform to double-entry accounting. Debits and credits either increase or decrease a particular account based on the nature of that account. In the case of recording debits and credits to the right account, the diagram below gives a great explanation.
To understand how debits and credits work, say Matty P’s Pizza Parlor has purchased more pizza toppings and needs to add that transaction to its general ledger.
The owner, Matty, spent $500 on peppers, onions, sausage, and pepperoni. This purchase would be recorded in an expense account since the act of purchasing the toppings increased the cost to the parlor. Since debits increase expenses, Matt would put a $500 debit next to the expense account. Because we’re using double-entry accounting, the $500 debit needs to be complemented by a $500 credit.
Since Matty bought these ingredients with money from his checking account and his checking account is considered an asset, the asset account would be credited $500. With a $500 debit balance in expenses and a complementary $500 credit in assets, Matt’s statements would be balanced.
|Matty P’s Pizza Parlor Account||Debit||Credit|
|Expense (Purchase Toppings)||$500|
Overall the general ledger should always have the total amount of debits equal to the total amount of credits.
Accounts make up the foundation of the general ledger. Your general ledger is broken down into several accounts—sometimes dozens of them. Accounts are the different reports your company keeps to sort and store your business transactions.
Most accounts will fall into one of five main categories: assets, expenses, liabilities, equity, and income. Examples of business actions that may affect these accounts include getting paid money, paying someone else money, or even transferring money into your bank account.
In addition to the five main accounts, all businesses will likely have different accounts specific to their operations. Because of this, it is recommended to create a chart of accounts for your organization.
Chart of Accounts: Unique list of the accounts that a company has identified and used for recording transactions in their general ledger. Learn more.
What’s a Subsidiary Ledger?
As a business grows, so will its number of accounts. That’s where the subsidiary ledger, or subledger, comes in. Subledgers are subsets of the general ledger. They group similar types of accounts and roll the total of those transactions to the general ledger. It is useful to consolidate related accounts, as it makes it easier to analyze and cleans up the overall general ledger.
For example, there could be a subledger that includes all accounts receivable transactions. This subledger would debit and credit each accounts payable transaction accordingly, and roll the total balance of the transactions into the general ledger. Then, if someone needs to review specific transaction data from the accounts receivable account, they can access the subledger for a more detailed view.
How Do Businesses Use General Ledgers?
The general ledger is the basis of financial reporting. This means that the details contained within the general ledger are used in developing reports like the balance sheet, income statement, and cash flow statement. Your company can use these reports to analyze the overall performance of your business.
The general ledger, however, is not a tool that is used to project a budget. Instead, it’s used to show the actual amount spent and received by your company, giving you a clear, accurate view of your small business transactions and the financial health of your business.
Before the age of technology, the general ledger was manually kept by a bookkeeper in a large book that took an even larger amount of manual work to keep up. With the introduction of automated accounting software, the general ledger is not only easier to maintain but also less prone to human error. With the help of your business’ chart of accounts, software can correctly distribute your transactions into the correct accounts automatically and make sure they balance every time.
Are you interested in automating your accounting and having a better way to keep up with your business’ general ledger? Talk to an expert to see how we can help.
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