What Is a General Ledger, and Why Do You Need One?

"Keeping the books.” It’s a common phrase that refers to maintaining the general ledger. But what exactly is a ledger, and why do you need one?

bookkeeper

Traditionally, accountants recorded financial transactions in the general ledger by hand, using the double-entry accounting method.

With the advent of computers, recording transactions became simpler. No longer did you have to record general ledger in books; you could use excel sheets and sophisticated accounting software.

While the way you record transactions has changed, the importance of the general ledger remains. It’s an essential accounting record for creating financial reports which are crucial for evaluating business health.

We’ll explore what a general ledger is, how it works, and why you need one.

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An Overview of the General Ledger and How it Works

The general ledger is a master accounting document providing a complete record of all the financial transactions of your business (accounts receivable and accounts payable). It helps you look at the bigger picture. Accounts include assets (fixed and current), liabilities, revenues, expenses, gains, and losses.

Before we continue, let’s look at a few key concepts that will help you better understand the general ledger and how it works. These accounting concepts refer to double-entry accounting, the basic accounting equation, and journals. Some may find them slightly overwhelming, but overall they’re fairly straightforward.

If I can understand them (someone who switches off at the mere mention of accounting terminology), then you can too! I’ve broken them down step-by-step.

1. Double-Entry Accounting

There are two primary types of accounting methods. The single-account method works just fine if you’re a solopreneur. But, the double-entry accounting method makes it easier to prepare financial statements and improves accountability. So, switching to the double-entry accounting method may be wise.

Regardless of what you decide works for you and your small business, general ledger accounts use the double-entry accounting method or financial reporting: An entry to one account requires an opposite entry to another account. Rephrased: Every time you entered a debit on a general ledger account you also have to enter a credit on another general ledger account.

A debit is an accounting entry that increases an asset, expense, or dividend account and decreases a liabilities or owner’s equity account, while credits decrease them.

Alternatively, credits increase liability, revenue, and equity accounts, while debits decrease them

Because credits and debits lead to the formation of an account that resembles the letter “T,” general ledger accounts are also known as T accounts. You find debits on the left and credits on the right.

We’ll look at a few general ledger examples shortly, but first, let’s review journals and the accounting equation.

2. Journals

Financial transactions are first recorded in journals before they’re transferred to a general ledger. If a general ledger is the master of all financial reports for looking at the bigger picture, journals are the documents for analyzing the finer details of your business.

Journal entries are usually recorded on a daily basis and, as with general ledger accounts, you’ll have a credit and a debit for each entry.

While there are 7 types of journals, the four most common ones are the sales journal, purchase journal, cash receipts journal, and cash payment journal:

  1. The Sales Journal is for recording credit sales. For example, customers (debtors) who bought on credit or account.
  2. The Purchase Journal is for recording credit purchases by your business. Examples are supplies and equipment.
  3. The Cash Receipts Journal is for recording all cash inflows, such as cash for services rendered.
  4. The Cash Payments Journal is for recording all cash outflows.

 

3. The Basic Accounting Equation

The purpose of double-entry accounting (some also refer to it as double-entry bookkeeping) is to make sure the basic accounting equation balances. The equation (Assets = Owner’s Equity + Liabilities) is the foundation of double-entry bookkeeping.

If at any time the sum of debits for all accounts does not equal the sum of credits, the equation will not balance. You’ll know you’ve made a mistake.



Examples

Let’s look at three examples and how to record the transactions:

Example 1: You pay an expense of $300

Debit “expense” and credit “cash” in BOTH the journal and the ledger.

Example 2: You receive $400 cash

Debit “cash” and credit “accounts receivable” in BOTH the journal and the ledger

Example 3: You owe $600

Debit “accounts payable” and credit “cash” in BOTH the journal and the ledger.

These are the basics, but you may be thinking, “So what? Do I even need a ledger?

Reasons Why You Need a General Ledger

Obviously, it’s always up to you (and your financial advisor) to decide what is right for you as a small business owner. You may be doing just fine without a General Ledger, accounting software or even an accounting system in place. But, just because we want to help you cover all your bases, here are seven compelling reasons why you may want to use a General Ledger to help track and evaluate every financial transaction for your small business:

  1. It provides an accurate record of all financial transactions
  2. It helps you compile a trial balance, so your books balance
  3. It makes filing tax returns easy because all expenses and income are in one place
  4. It reports real revenue and expenses so that you can stay on top of spending
  5. It helps you spot unusual accounting transactions immediately
  6. It helps you identify (and stop) fraud
  7. It aids in compiling key financial statements which are crucial for evaluating your profitability, liquidity, and overall financial health. These include the cash flow statement, income statement, trial balance, and balance sheet.
accounting software checklist

The Accounting Cycle

We covered this briefly above, but organizing your accounting steps and processes is an important part of proper double-entry accounting.

Financial documents like the income statement, balance sheet, and cash flow statement show the financial health of your business. Using accounting software, any small business owner can run and review any of these three statements, which also includes the general ledger. Here are the 4 steps in the accounting cycle:

  1. Gather source documents: Ensure you have all transactions from receipts and invoices properly accounted for and entered into your accounting system.
  2. Post journal entries: Each journal entry has an account number, a date, an amount, and an entry description.
  3. Record entries in the general ledger: Journal entries appear in the general ledger. Using accounting software like FreshBooks is a super-easy way to track all entries and maintain tight general ledger accounting records.
  4. Financial Reporting: To produce the financial statements, your accountant will generate a trial balance that lists each account and the current balance. You can use an adjusted trial balance to generate different financial reports.

When it comes to financial statements, a company’s primary record of all accounting is the general ledger. Understanding this cycle from beginning to end and maintaining proper financial data is important, but that doesn’t mean you need to do it all manually in an excel spreadsheet. Good accounting software should do all of this work for you. All you have to do is enter your expenses and track revenue, everything else should be automatically categorized in a general ledger account.

Should You Worry About Subsidiary Ledgers?

Unless you’re an accountant yourself and want to incorporate sub ledger accounts into your books, most small business owners will find it too complex and time consuming. On top of that most small businesses don’t need subsidiary ledger accounts as they’re typically used in large organizations with very complex general ledgers and financial information.

Conclusion

General ledgers are master financial statements that record all the financial transactions of your business. Sound important? When it comes to financial accounting and keeping every business transaction accounted for, the general ledger has no equal. Understanding how it works can be daunting, and if you really can’t wrap your head around it in an effort to understand your financial performance, then talk to an accountant.

You just need to understand the fundamental principles of double-entry accounting, the basic accounting equation, and how to transfer journal entries to the ledger.

Once you understand and start using the general ledger, you’ll realize how powerful it is. It offers several compelling benefits for your business. Arguably, the most important is that it’s the foundation for creating financial statements that are critical for evaluating your financial affairs.

This post was updated in January 2022.

Reviewed for accuracy by Janet Berry-Johnson, CPA.



Nick Darlington
about the author

Freelancer & FreshBooks Customer Nick Darlington is a FreshBooks customer and small business owner who's been running a writing business for close to 4 years now from his home in sunny South Africa. When he’s not sharing his knowledge and experience about how to successfully run, manage, and grow a small service business, he’s helping aspiring and established writers succeed at WriteWorldwide.