Whether you’re a sole trader or a multinational corporation, businesses of all sizes are required to keep records of financial transactions. The general ledger is where you record and maintain these transactions, providing a vital accounting record for your official financial reports.
General ledger basics
General ledger basics boil down to record keeping. The term simply refers to the financial record-keeping system that a company uses to keep track of its data. This includes both debit and credit accounts, allowing businesses to balance transactions. Financial data is separated into separate accounts for expenses, revenues, equity, liabilities, and assets; all of which make up the entirety of the general ledger.
By holding all this information in one place, the general ledger forms the basis of a double-entry accounting system. It’s essentially a master document used to produce all important financial documents, like the balance sheet and income statement.
How does a general ledger work?
When answering the question of ‘what does general ledger mean’ it’s also important to understand the purpose of this document. Transactions are recorded in the general ledger as separate journal entries to each sub-ledger account. These journal entries can then be summarised to the general ledger with a trial balance, checked for errors, and adjusted for use in the official financial statements.
It’s also important to understand the concept of double-entry accounting when looking at how the general ledger works. When following the double-entry bookkeeping method, accountants create two journal entries for each financial transaction. One goes in the debit column, and one in the credit column.
Double-entry accounting follows the accounting equation:
Assets = Liabilities + Stockholders’ Equity
This is reflected on the balance sheet, which shows various asset accounts including accounts receivable and cash, along with liabilities. Recording all this information in the general ledger first helps businesses process the data to ensure it follows the accounting equation.
How to prepare a general ledger
The first step when looking at how to prepare a general ledger is to follow the double-entry accounting method, which stipulates that an entry to one account must be offset with an opposite entry to another account. In other words, a debt must be balanced with a credit.
To prepare a general ledger, you should set up two columns, with debits on the left and credits on the right.
You’ll then pull financial data from your company’s journal entries and enter the debits and credits into the ledger. All transactions should be recorded in these sub-ledger journals daily. Some of the most common journals include the following:
Purchase Journal: includes all credit purchases for the business, like equipment and supplies
Sales Journal: records all credit sales, including customers who have purchased products on credit
Cash Payments Journal: records all cash outflows
Cash Receipts Journal: records all cash inflows
Finally, after inputting your journal entries into the general ledger, you need to balance the books using the accounting equation. If the sum of debits doesn’t equal the sum of credits, this means there’s an error somewhere in your journals which should be investigated.
General ledger example
A general ledger comprises all the following balance sheet accounts:
Asset accounts including accounts receivable, inventory, investments, and cash
Liability accounts including accounts payable, accrued expenses payable, and notes payable
Equity accounts including common stock, treasury stock, and retained earnings
As a general ledger example, imagine that your company received £300 as a cash payment from a client. You would record a debit in ‘cash’ and a credit in ‘accounts receivable’ in both the ledger and journal.
Why should you use a general ledger?
Because you already must record these transactions in the official income statement and balance sheet, is there any need for a general ledger? There are a few advantages to using this system. The main benefit is that it gives you a day-to-day record of all financial transactions. If your company realizes that an accounting error has been made, going back to the ledger should reveal where the issue lies. This helps prevent fraud, as you can spot any unusual transactions straight away.
The trial balance makes it easier to keep your official books balanced, and also eases the burden of filing tax returns since you have all income and expenses in one master document.
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