Businesses have been using the general ledger for centuries as a master document for recording all the financial transactions of their business. But, how does it work?
You first record transactions in journals before transferring them to the ledger. There you assign the transaction to two different accounts, either on the debit or credit side. The goal is to make sure debits and credits are equal, and that the basic accounting equation (Assets = Owner’s Equity + Liabilities) balances.
The general ledger is very much a part of the accounting process. But the ledger is more than a master document and it’s certainly more than just another accounting record.
This post will reveal the magic that the ledger offers, and—dare I say—help you fall in love with it. We’ll highlight the many benefits and show you why it’s the most important reporting tool for your business.
Ledgers record all financial transactions for the lifetime of your business. You can access all the financial transactions in one place; you don’t have to dig through individual journal entries to find it. One master record is even more helpful come tax season.
Ever found yourself running around come tax season? You sift through emails, old invoices, and many journal entries. Not only is it stressful, but it’s time-consuming.
Enter the general ledger!
By accurately recording expenses and revenues you’ll have one central record of your transactions. This will help you construct accurate expense and income reports so that filing your tax returns becomes a breeze.
By transferring journal entries to your ledger, monthly, you can stay on top of your spending and adjust your budget accordingly.
Your ledger is the foundation for creating a trial balance. It’s crucial for checking that your debits and credits are in balance, and that the accounting equation balances.
By analyzing your ledger, you can identify unusual transactions. These transactions may range from accidental mistakes—such as double debits on your account—to deliberate attempts by someone to deceive you for financial gain.
Margie Reinhart of Bridgepoint Consulting mentions how an audit of one company revealed that they were moving journal entries between accounts to paint a picture of insolvency.
The entries reduced assets and equity by $20 million. Why on earth would a company want to do that? Well, they didn’t want to pay their largest creditor who they owed $10 million.
The ledger is essential for determining the financial health of your business. It’s the foundation for compiling three critical financial statements: The cash flow statement, income statement and balance sheet.
These statements help you track profit, losses and financial health. Without the ledgers and the statements, your business’s financial health can remain a mystery.
Cash Flow Statement
This statement shows you how much cash inflow or outflows you have. Put differently; it shows you how you’re making and spending money.
If inflows are higher than outflows, you have a positive cash flow. If you’re struggling to make loan repayments, pay employees and cover other operating expenses, chances are, you have a deficit.
Your cash flows statement records cash across operating, investing, and financing activities and is an excellent indication of your liquidity and short term viability.
Also known as the profit and loss statement, the income statement reports on the profitability of a business for a short period, usually a month, quarter, or year.
Unlike the cash flow statement, it includes non-cash items such as depreciation. It provides a summary of revenues and expenses for operating and non-operating activities.
The “operating” section will include the income and expenditure related to the company’s operation, and the non-operating will include those that aren’t.
While management will use it to assess profitability and performance, outside investors and creditors use it to make risk assessments.
Income statement line items include sales, rent expense, interest expenses, and loss on disposal of assets.
“A balance sheet is like a thermometer that provides a reading on the health of your business. Ignoring it could be fatal,” writes Norm Brodsky, Inc Contributor.
Those two sentences sum up the importance of a balance sheet for your business. Balance sheets help determine the financial standing of your company at a particular period. It shows what you own (assets), what you owe (liabilities), and the value of your business to stakeholders (equity).
If your ratio of assets to liabilities is less than 1:1, your business is technically bankrupt. By updating and checking your balance sheet often, you can avoid these situations.
But balance sheets also offer other benefits: they let banks know if you qualify for credit and help investors make sound investment decisions.
Your ledger is far more than a master accounting record of your business’s financial transactions. It’s a record that offers many benefits for your business:
More importantly, it’s a reporting tool used to compile three critical financial statements: The balance sheet, income statement, and cash flow statement.
Use them to assess your liquidity, profitability, and business health.
So, instead of seeing your ledger as just another document, maybe it’s time you saw it as a powerful reporting tool? One that helps you get to grips with your financial affairs and one that actually improves business performance.