5 things to know about the General Ledger
All businesses require a bookkeeping system that is accurate, reliable and provides a detailed overview of their current financial situation. The general ledger is one of the most valuable and important accounting tools a business owner can have.
Understanding the basics of how a general ledger is created and what must go into it is fundamental knowledge for any responsible business owner. Whether you are self-employed or the director of a company, you should appreciate how valuable the general ledger is to your enterprise. In this article, we will provide you with a short guide to the general ledger, what it is, what accounts it covers and how it works.
What is a general ledger?
A general ledger acts as the main accounting record of a business. Every financial transaction that occurs within an accounting cycle or financial year is recorded in the general ledger. This information is vital for the preparation of tax documents and financial statements and provides a clear picture of how well a business is performing.
The general ledger contains details of all monies that have been spent by the business and all revenue that has been earned. All changes to assets owned by the business are recorded in the general ledger, as well as all liabilities, a list of expenses and the equity of the business.
The general ledger is divided into different accounts. It shows all credits and debits that have occurred in these accounts for the accounting period. Each account will have an opening and a closing balance. The precise account details are contained within subledgers. The general ledger acts as a broad overview of the information that is in the subledgers.
Some business owners employ accountants to keep their general ledgers, while others may prefer to manage the general ledger themselves. A general ledger can be kept in digital form as a spreadsheet, be created by a dedicated accounting software package such as Quickbooks, or it may be an old-fashioned paper book.
The typical layout of a general ledger
Usually, a general ledger will be laid out in two sections. The left section has a list of all debit transactions while the right section lists all the credit transactions. These two sections must balance. If they do not, there may be an accounting error, or the business may be in financial difficulties.
What accounts are listed in a general ledger?
The types of accounts or subledgers contained in the general ledger can vary depending on the scope and nature of the business. However, there are some typical accounts that you might expect to find in every general ledger. These accounts are:
- Assets – A detailed list of all current assets and fixed assets owned by the business. This can include cash, equipment, machinery, inventory, stock, accounts receivable and real estate.
- Liabilities – All financial obligations that are outstanding. As in, what debts the business has at the time. All accrued expenses, accounts payable and long-term and short-term loans are detailed in this section.
- Equity – Sometimes referred to as the capital ledger this account lists all the money that has been invested into the business. It provides details on retained earnings, dividends, as well as stock held by directors or by the owner.
- Revenue – All earnings generated from the main business activity of the enterprise are recorded in this account. This can include interest from loans, income generated from sales, dividends, or investments.
- Expenses – any expenses relating to the daily operations of the business are recorded in this section. Expenses can be either direct expenses or indirect expenses. The list of expenses can include costs such as utilities, rent, maintenance of equipment and facility management fees. Expenses also include the cost of raw materials, staff wages and the depreciation of fixed assets.
How general ledgers work
All financial transactions pertaining to a business are recorded in subledger accounts within the general ledger. These accounts are then closed out and the totals are recorded in the general ledger itself. All general ledgers use the double-entry accounting method.
With the double-entry accounting method, every transaction impacts at least two different subledgers. Each transaction entry has one debit and one credit listing, although in some cases there can be more than one listing. Double-entry transactions are known in accounting terms as journal entries.
Double-entry accounting is based on what is known as the accounting equation. This principle holds that the total of a business’s assets must be equal to the sum of its equity and liabilities. This equation is also used in other accounting records such as the balance sheet.
Let’s take a look at an example:
A business has an expense of £500. To record this expense, journal entries must be made in the relevant subledgers. The expenses account is debited, so it increases by £500. The cash account lists the payment under the credit section, decreasing the total by £500. At the end of the accounting cycle, all subledgers are totalled and this information is then transferred into the general ledger.
Once this has been done, the general ledger must be balanced using the accounting equation. If it does not balance, then this may mean that the information was incorrectly transferred. The balance of the general ledger is then recorded in the trial balance. Once again, the total credit of the trail balance should match the total debit, as stipulated by the accounting equation.
When the trial balance has been calculated, an accountant or bookkeeper can then use this information to create the balance sheet and a profit and loss statement for the relevant accounting period. The general ledger should be kept for at least six years, as per UK accounting retention practices.
Why is having a general ledger important?
Not all businesses keep a general ledger. Some operations are not big enough to warrant having one. However, a general ledger can provide valuable insights into the financial state of a business, regardless of how big or small it is.
By using a general ledger, a business owner can ensure that they are keeping a close watch over all transactions made by the business. The data in the general ledger can be used to identify if there are any unusual transactions or instances of fraud.
Also, the data in the general ledger is used to create the three main financial statements. These are the cash flow statement, the income statement and the balance sheet. These documents show what a business’s assets are worth and how much debt it is carrying. This information can be used to attract investors or obtain loans from financial institutions.
The general ledger lists all expenses and income, so it makes it easier to prepare tax returns, which can save on accounting expenses.
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