Every business must record financial transactions to track profits, monitor client relationships, stay current on taxes, and keep an eye on the financial health of the company. To make all this information accessible in one place, businesses group transactions in the general ledger.
When using general ledger accounting, a company compiles financial data from all sectors of the business in a single, comprehensive spreadsheet. All money entering and exiting the company is documented in a general ledger account. Here’s an overview of general ledger accounting and ways you can use it to monitor your organization’s financial transactions.
What is a general ledger?
A general ledger (GL) is a central accounting record that contains all the financial transactions of a business. The general ledger functions as a comprehensive and organized account of a business’s finances, including purchases, sales, expenses, revenue, and other cash flows.
Traditionally, businesses assign account numbers to individual accounts, each of which represents a type of financial transaction. These accounts include assets, liabilities, owner’s equity, revenue, and expenses. All these accounts are indexed in the company’s chart of accounts.
Each of these accounts is updated using records called journal entries. A journal entry documents the details of a financial transaction, including date, description, amount, and the affected accounts. The financial information from a journal entry is then posted or recorded in the corresponding accounts in the general ledger. Modern accounting software (including small business accounting software) can do this automatically, updating account balances and generating financial statements that track every transaction within a general ledger.
General ledgers and double-entry bookkeeping
Double-entry bookkeeping is a fundamental accounting method that revolves around the balance sheet equation, which is as follows:
Assets = Liabilities + Equity
In the double-entry accounting method, every transaction has two equal and opposite entries, one as a debit and one as a credit, ensuring the accounting equation always is in balance. Bookkeepers monitor accounting data to make sure that credits and debits balance one another out.
How does a general ledger use double-entry bookkeeping?
A general ledger relies on double-entry bookkeeping by counterbalancing debits and credits across corresponding accounts. For instance, a credit in one asset account—let’s say inventory—might be offset by a debit to accounts payable (a liability account) or cash (another asset account), to reflect the money owed or spent to pay for the inventory.
These debits and credits contribute to a trial balance, which is a statement that summarizes the balances of all accounts in the general ledger at a specific point in time, typically at the end of an annual or quarterly accounting cycle. Each financial transaction affects the total trial balance. If errors are spotted in the course of auditing (for instance, a missing entry in a cash account), an accountant can address them and produce an adjusted trial balance.
Why do companies use general ledgers?
- Record keeping and organization
- Real-time financial position data
- Preparing important financial statements
- Tax preparation and reporting requirements
- Budgeting and financial planning
Companies use general ledgers as a central hub for organizing and recording all their financial processes. The general ledger stores transaction data linked to all of a business’s assets, expenses, liabilities, and more. The main functions of a general ledger include:
Record keeping and organization
The general ledger is a central repository to record transactions like sales, purchases, payments, receipts, investments, loans, and more in a systematic and organized manner. This allows for easy tracking, retrieval, and reference of financial data. Each transaction is entered into the appropriate account as a debit or credit.
Real-time financial position data
The general ledger provides an up-to-date snapshot of a company’s cash position, including the balances of various accounts such as assets, liabilities, equity, revenue, and expenses. This real-time accounting data helps company stakeholders make financial planning decisions.
Preparing important financial statements
Accountants use general ledgers to produce financial statements like balance sheets, income statements, and cash flow statements. These statements, which may be distributed to employees and prospective investors, among others, offer insights into a company’s financial performance, profitability, liquidity, and solvency.
Tax preparation and reporting requirements
The general ledger ensures compliance with generally accepted accounting principles (GAAP), a set of guidelines all public companies must follow. By accurately recording each business transaction and maintaining detailed account balances, companies can meet regulatory and statutory reporting requirements. They can also produce documents, like an income statement, that aid accountants who file taxes on behalf of the business.
Budgeting and financial planning
Financial processes like budgeting and strategic planning rely on the general ledger. Historical data from the ledger can help companies analyze trends, forecast financial performance, and establish budgets for various business activities.
A general ledger helps those who conduct financial audits. It serves as a central hub of an accounting system when verifying individual transactions and confirming the accuracy of income statements and other financial reports. Auditors use general ledgers to flag innocent accounting errors or unearth financial malpractice.
Elements of general ledger accounts
Finance professionals break general ledgers into five fundamental account types. They use these elements to classify and organize transactions into debit balances and credit balances, which they then use to generate financial statements. Debits increase assets and expenses, while they decrease liabilities, equity, and revenue. Credits increase liabilities, equity, and revenue, while they decrease assets and expenses.
The five core general ledger accounts (and their debit and credit components) are:
An asset account tracks cash, property, machinery, inventory, accounts receivable, securities, and other resources a business owns. For example, when you sell a product and earn cash, you credit the inventory account and debit the cash account; both cash and inventory are asset accounts. When you purchase a new piece of machinery, you debit the equipment asset account (with a corresponding credit to either liabilities or cash to reflect the amount you pay). You can similarly handle sales of property, depreciation, and investment losses.
In financial reporting, liabilities represent money owed to others. This includes loans, accounts payable, your mortgage, credit card balances, payroll taxes, and more. Liabilities are effectively the opposite of assets. For example, when you make a payment on a loan, you would credit your cash account (an asset account) and debit the loan account (a liability account).
Equity refers to your (and other shareholders’) ownership stake in a business, as well as retained earnings—the portion of a company’s profit that is held for future use. Here, you would also include owner cash withdrawals and operating losses that reduce the value of owner’s equity. If, for example, you raised more capital by selling shares of common stock, you would credit the common stock account (an equity account) and debit the cash account (an asset account).
Revenue accounts reflect money coming into your business. Credits include income from product sales or services rendered, as well as income generated from other business activities, such as charging rent. For any income your company earns, you would credit revenue and debit cash. Debits in the revenue category are rare and include revisions that reduce revenue due to an earlier error.
Expense accounts track money spent while doing business. You debit an expense account when you pay for utilities, insurance, rent, legal fees, cost of goods sold, and payroll. Expense accounts are almost exclusively debited, but you might credit an expense account when you receive a refund or close the account.
General ledger accounting FAQ
What are the five elements of a general ledger?
The five elements of a general ledger are assets, liabilities, equity, revenue, and expenses.
What is the difference between a balance sheet and a general ledger?
A balance sheet is a financial statement that provides a snapshot of a company’s assets, liabilities, and equity at a given point in time—typically at the end of a quarter or year. A general ledger is a comprehensive record of all financial transactions that occur within a company, including everything represented on a balance sheet.
What is general ledger reconciliation?
General ledger reconciliation is the process of comparing and verifying the accuracy and consistency of the financial transactions recorded in the general ledger and any control account housed within it. These control accounts are associated with specific categories of transactions—such as receivables, payables, or inventory—and help consolidate and summarize the data from many individual accounts.