Before computers and software, we did all of our accounting by hand. Business owners kept any accounting records in large binders with reams of paper files. Fortunately, accounting has gone digital, and as a small business owner, you can automate your financial transactions with accounting software
Financial statements like income statements, balance sheets, and cash flow statements show the financial health of a business. Business owners can generate all three statements using the accounting cycle, which includes the general ledger. The accounting cycle has four steps:
- Gather source documents. Transactions post from source documents like receipts and invoices. Each accounting document is used to post a journal entry.
- Post journal entries. A journal entry includes an account number, a date, a dollar amount, and a description of the entry. In some cases, accountants post information to control accounts and then transfer the data into a journal entry.
- Record entries in the general ledger. The journal entries post to the general ledger. While some small businesses use Excel, accounting software is a more efficient way to maintain general ledger accounting records.
- Generate financial reporting. To produce the financial statements, the accountant generates a trial balance that lists each account and the current balance. You can use an adjusted trial balance to generate financial reports.
In financial accounting, a company’s main accounting record is its general ledger. Although there are tools that automatically categorize these transactions, it’s still important to know the basic components of general ledger accounts. Knowing the components means you can spot potential issues in your financial data.
What is a general ledger?
A general ledger is a record keeping system used to sort, store, and summarize a company’s financial transactions. A general ledger has four primary components: a journal entry, a description, debit and credit columns, and a balance.
- A journal entry: The number of each journal entry posted to the account and the date of the entry.
- A description: A description of the transaction.
- Debit and credit columns: Each journal entry posts a debit or credit to the general ledger.
- A balance: A general ledger lists the account balance each time a debit or credit posts to the account. At month-end, after all the journal entries post, the ending balance is calculated.
You can use the account balances in the general ledger to generate the trial balance. A trial balance lists every account and the current account balance. The dollar amount of total debits must equal total credits in the double-entry accounting system.
General ledger accounts include five account categories. The balance sheet uses three categories (assets, liabilities, and equity), and the income statement reports two categories (revenue and expenses).
Example of a general ledger
Let’s review the cash general ledger account for Centerfield Sporting Goods. Account #1000 is the cash account. It’s a partial listing of the general ledger for January 2020. The ledger reports each journal entry that impacted the cash account. Note the following:
- The January 1 beginning balance is $80,000, and the balance matches the December 2019 ending cash balance.
- The debit balances and credit balances post in separate columns.
- Purchases made on January 1 and January 5 decrease the cash account. Journal entry #1 indicates that inventory is debited (increased) by $10,000, and cash is credited (reduced) by $10,000. If you checked the inventory general ledger account, you’d also find journal entry #1.
- A customer makes a cash payment on January 9, and the cash account increases with a $6,000 debit.
On January 31, after all of the cash journal entries posts, the general ledger lists the ending cash balance.
5 general ledger account categories
General ledger accounts categorize as assets, liabilities, equity, revenue, or expenses. The general ledger also lists the chart of accounts.
Assets are resources with an economic value that businesses use to generate revenue. An asset may be tangible (a piece of equipment) or intangible (copyright). Assets may include cash, inventory, property, trademarks, and patents.
Liabilities are obligations that a business owes to another business or individual. Liabilities can include employee payroll, bank loans, mortgages, or leases.
Equity is the difference between total assets and total liabilities. If a business sold all of its assets for cash and it to repay all liabilities, any cash remaining is equity. The equity balance has three components:
- Common stock. If the company issues stock to investors, the common stock balance is the number of shares issued multiplied by the stock’s par value. Typically, par value is $1 or $5 per share.
- Additional paid-in capital. This is the dollar amount that investors pay for common stock above the par value. If $1 par value stock is $10 per share, $9 per share posts to additional paid-in capital.
- Retained earnings. A business can choose to pay earnings to shareholders as a dividend or retain earnings for use in the business. The retained earnings balance subtracts total company earnings since its inception from total dividends paid to shareholders.
Small businesses that don’t issue stock use an account called owner’s equity, instead of common stock. The owner’s equity is the total cash and other assets that owners contribute.
Revenue generates from the sale of a good or service. Revenue includes sales, interest income, royalties, and any other fees that the business collects.
A business incurs expenses to generate revenue. Rent and utilities are typical business expenses.
Categorizing balance sheet and income statement accounts
General ledger accounts post to the balance sheet or the income statement. These categories stay in place, regardless of the business’s accounting method.
Balance sheet accounts
Balance sheet accounts are permanent accounts. The balances in these accounts are reported on the balance sheet and carry over from one period to the next. Balance sheet accounts include:
- Asset accounts (cash, accounts receivable, etc.)
- Liabilities (accounts payable, loans payable, etc.)
- Equity accounts
Income statement accounts
Income statement accounts are temporary accounts. These balances are closed at the end of each month, so the next month begins with a zero balance. Income statement accounts include:
- Revenue (sales, investment income, etc.)
- Expenses (salaries expense, rent expense, interest expense, etc.)
The chart of accounts is a list of all of the accounts used to record transactions. The number of accounts in the chart of accounts may be greater than the number of accounts in the general ledger. Accounts with zero balances or no recent entries are often omitted from the general ledger. But they will still appear on the chart of accounts.
What are sub-ledgers?
Sub-ledgers, or subsidiary ledgers, within each account provide additional information to support the journal entries in the general ledger. Sub-ledgers are used when a particular account has a lot of activity.
For example, the accounts payable general ledger account may use information from a purchase’s sub-ledger account. Separating purchases provides more detail and makes it easier to review account activity.
How does a general ledger work?
A general ledger uses the double-entry accounting method for generating financial statements. Double-entry accounting uses debits and credits and dollar amounts.
- Debits and credits: Each journal entry must have at least one debit and one credit entry. The number of debit and credit accounts used, however, does not have to be equal.
- Dollar amounts: The dollar amount of total debits and credits must balance.
For example, if a company makes a sale, its revenue and cash increase by an equal amount. When a company borrows funds, the cash balance increases, and the debt (liability) balance increases by the same amount.
Double-entry bookkeeping keeps the accounting equation (or balance sheet equation) in balance. The balance sheet formula adds liabilities and owner’s equity to determine a business’s assets. The balance sheet formula follows:
Liabilities + owner’s equity = assets
If the accounting equation is not in balance, there may be a mistake in your journal entry. Some accounting solutions alert users when a journal entry does not balance total debits and credits.
What information does a general ledger tell you?
The general ledger can help generate financial statements for stakeholders like investors, creditors, and regulators. Ledger information can also produce management reports for decision-making purposes.
When a business owner notices a sudden rise in expenses, they can investigate the general ledger to determine the cause of the increase. If there are accounting errors, an accountant can dig into the general ledger and fix them with an adjusting entry.
Every business must strive to maintain accurate accounting records to generate reliable financial statements.
What is the difference between a general ledger and a general journal?
A general journal is a record of every business transaction in chronological order. It is the first point of entry into the company’s accounts. The general journal is a good place to review all accounting transactions.
Generally, a transaction posts to the general journal before it makes its way to the general ledger. The general ledger is the second point of entry for recording transactions after it enters the accounting system through the general journal. The general ledger is a summary of every business transaction at the account level.
Both the general journal and the general ledger provide a way to record business transactions using double-entry accounting. The information entered into the journal and summarized in the ledger can generate financial statements.
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 an accountant or bookkeeper, 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 that you can track the sales and costs of specific products. You’ll be able to track inventory and vendors and monitor anything else that can help you make informed decisions.
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