The general ledger has been a cornerstone of good accounting since the dawn of time. Prior to digitization, accountants would literally ‘keep the books’ by handwriting entries into big ledgers, and it was how organizations of all sizes kept track of each and every transaction.
Today, the general ledger still plays a big part in the financial process. Even with automated accounting software, accountants have to track all financial records so there’s visibility over money coming in, and money going out.
Here’s what you need to know about general ledger accounting, and how it affects your ability to report the success or failure of your organization.
The general ledger: a short introduction
The general ledger is a master accounting document that offers a complete record of all financial transactions at an organization. This includes all debit and credit transactions, like revenue, expenses, assets, liabilities, and even ownership equity.
The general ledger is also used to generate key financial reports for an organization, including a balance sheet, and a profit and loss statement.
Within general ledger accounting, there are three core concepts to know:
- Double-entry accounting;
- Basic accounting equation; and
Here’s a brief overview of each concept.
The double-entry bookkeeping method
In this accounting method, an entry on the debit side must be accompanied by a corresponding entry on the credit side.
Quite simply, every entry into a debit account will impact the credit account, and this must therefore be recorded, too.
For example, when an accountant enters a credit entry into the credit account, this increases an owner’s equity and positively impacts the liabilities account. As a consequence, the debit account will decrease because there is now more cash in the bank.
This ‘balancing act’ accounting method is commonplace among finance teams, and many organizations choose to record their debits and credits using this approach.
Prior to recording something in the general ledger, accountants must first enter records into ledgers. These journal entries provide an in-depth look at specific areas of accounting, while the general ledger provides a holistic view of financial performance.
There are seven types of journals to know. These are:
- Cash receipts journal: this shows all cash inflows
- Cash payment/disbursement journal: this shows any cash flowing out
- Sales journal: this shows all sales made on credit
- Purchase journal: this shows all credit purchases made by a business
- Purchase return journal
- Sales return journal
- General journal
These seven journals are the lifeblood of the finance team, and they’re used almost every day to record the various incomings and outgoings.
Basic accounting equation
The primary benefit to double-entry bookkeeping is to ensure that the basic accounting equation balances. This equation is:
Assets = Owner’s Equity + Liabilities
At any time in an organization’s lifespan, this equation should balance. If it doesn’t, then ‘the books’ are imbalanced and the accountant responsible will have to provide an explanation.
To provide an example: if you pay an expense of $200, you enter a debit entry of this amount in the expense side and credit the cash side. This must happen in both the journal and the general ledger.
Bonus! The importance of income statements
As well as the basic accounting equation, an organization’s income statement must also balance at all times. This is:
Revenue – Expenses = Net Income (Profit)
If a customer is billed $200, for example, this amount is posted as a debit in the accounts receivables and a credit to the revenue. If your expenses are unchanged, then, your net income will increase.
Sidebar: What is general ledger reconciliation?
General ledger reconciliation is the process of ensuring that the general ledger is in balance. By reconciling all transactions, you ensure that all entries are correctly entered and that your books balance.
In most instances, the reconciliation process is performed by a qualified Certified Public Accountant (CPA).
Balancing the books is important for two reasons:
1. It shows a complete record of financial activity
The general ledger shows every single transaction that an organization makes. While capturing everything is difficult to do manually, the right accounting software allows accountants to capture financial information down to the cents. This makes for high visibility into financial performance and creates a strong audit trail.
A ‘balanced book’ also provides the foundation for checking every other financial statement. If the general ledger doesn’t balance, it opens up the investigation into specific financial areas of an organization, and this can lead to smarter processes and innovation in record keeping.
Regularly balancing the books helps spot missing information quickly, which safeguards against large and unseen financial losses.
However, real-time speed is only possible with the right accounting software. With an automated approach to the general ledger, accountants can receive instant alerts as soon as a wrong entry is made. This ensures accurate information is available at all times.
2. It improves spend management and ensures a strong financial position
There’s a lot of power in the general ledger. It assists in more accurate financial reporting on revenue and expenditure, and it creates clarity around what items take up the biggest share of capital.
In short, this allows finance teams to make strategic decisions to improve operational efficiency and reduce costs. It also ensures a healthy cash flow position and leads to things like investor attraction.
Why do you need a general ledger?
It’s up to you how well you want to understand your financial position. For many smaller businesses, a general ledger costs more in time than it does in financial success, and many small business owners opt out of such scrutinized record keeping.
For larger organizations, however, the general ledger is the finance team’s source of truth. Here are a few reasons why.
1. It assists in tax reporting
The general ledger consolidates all income and expenses into one place, making it possible to perform tax calculations quickly and easily. Of course, with the right accounting software, you can configure it to auto-generate tax reports for you, which not only saves you time, but also reduces human error and increases compliance.
2. It helps to check and prevent fraud
When you document every financial transaction, you gain complete clarity over money in, and money out. This makes it easy to spot fraudulent purchases made on behalf of the organization, which helps prevent heavy financial losses before they happen, not after.
3. It’s easy to show classified accounts
For organizations with sensitive financial transactions, the ledger can paint an accurate picture of what is happening in those accounts without delving into their details.
Quite simply, the general ledger serves as the basis for the income statement, cash flow statement, and the balance sheet, and shows key metrics like profitability, liquidity, and the overall financial health of a business.
Use technology to build end-to-end financial reporting
Before the internet, accountants wore wrist braces to counteract the laborious act of manual data entry (we’re not joking). It was painstaking work that required a lot of time, and even more patience.
While the general ledger still plays an important role in financial reporting today, with the right technology, finance teams can automate the documentation of day-to-day transactions and free up time to focus on more important things, like data analysis and strategic direction.
However, building a visible picture of the pre-accounting, accounting, and payments processes with just one tool is near impossible. But, with the right tools in place that seamlessly integrate into one another, finance teams can manage and control actions such as procurement, and then feed that data into their accounting tool to ensure an accurate general ledger and a well-balanced book.
To find out how Procurify integrates with QuickBooks Online, explore here.
Editor's note Original publish date: 4 July 2018 We've since updated and republished this blog post with new content.