Fortunately, if you've arrived here, you're asking the right questions—or at least one of them—specifically, "What is a general ledger?"
Understanding what a general ledger is and how it works (along with a few closely related and relatively straightforward concepts) will provide you a solid base of knowledge with which you'll be able to gain a better understanding of bookkeeping and accounting in general, and more importantly, what it all means for your business.
What is a general ledger?
When it comes to bookkeeping for your business, the most essential record you'll use to understand its overall financial health is the general ledger, also known as a principal book of accounting, and sometimes referred to as a general journal or simply a GL. Luckily, the general ledger definition is straightforward: It is a financial master document showing a comprehensive record of all business transactions and financial data needed to generate income statements, balance sheets, and financial reports, allowing founders and other stakeholders to quickly get a big-picture look at your business's finances.
The general ledger for most businesses includes five subsidiary ledgers. Though some businesses may have more sub-ledgers, all individual transactions the business conducts is entered into the ledger under at least one of these categories. Here we've listed the five types of general ledger accounts, along with a few examples of accounts classified under each type:
- Assets (accounts receivable, inventory, investments)
- Liabilities (accounts payable, mortgages, deferred revenues)
- Revenues (sales, service revenues, interest income)
- Expenses (salaries, expense accounts, rent, depreciation)
- Stockholders' equity (common stock, preferred stock, retained earnings)
Each of the accounts in the general ledger has its own sub-ledger accounts, exclusively dedicated to invoices and financial transactions that affect that account, where you can view transactions in greater detail. (If you’re getting hung up on the question, “What is a ledger?” it’s just a book where you will record transactions of a given account/accounts.)
A Few Key Concepts To Know
To understand how a general ledger works, you'll need to understand a few related concepts: journals, the basic accounting equation, and double-entry bookkeeping.
Journals
Before being entered into a ledger, all transactions are first recorded in a journal, which is sometimes referred to as a “book of first entry” or “book of original entry” because it’s the first place a business records transactions. A journal entry consists of a description of the transaction, the date of the transaction, the accounts it affected (as dictated by the chart of accounts), the amount(s), and for most businesses will be entered in the double-entry bookkeeping method (more on that in a moment).
Generally, a business enters transactions into a journal as they occur so that all information is as accurate as possible, rather than having to reconstruct or guess details at a later date. Though journal entries have traditionally been made manually, some forward-thinking accounting firms are now using artificial intelligence (AI) and machine learning (ML) to automate the task.
Double-Entry Bookkeeping
In order to create a general ledger, a business must use the double-entry method of bookkeeping. In this method, every transaction generates at least two entries—including at least one debit and one credit—which respectively describe whether money is moving to or from an account.
Each transaction in the double-entry accounting method impacts at least two different accounts, and the amount of debits must equal the amount of credits. For example: If a hardware store sells a hammer, the entry for that purchase will show an increase in both the cash and revenue accounts, along with a decrease in the inventory account. In other words, double-entry bookkeeping tracks both where money is coming from and where it’s going. If a business doesn’t record transactions in a journal according to the double-entry method, they won’t contain the information necessary to create a general ledger.
The Basic Accounting Equation
The foundation of the double-entry accounting system is a simple formula:
Assets = Liabilities + Equity
In the equation, assets are resources that the business owns, like cash, equipment, buildings, and even intellectual property like patents or copyrights. Liabilities are obligations the business owes another entity, like accounts payable owed to a supplier or a mortgage owed to a bank. Equity is the amount that would be due to the business’s owners after all debts and liabilities are paid and can include contributions the owners have made to the business, plus profits or minus losses as calculated by deducting expenses from revenue.
Each transaction entered to both the journal (and later, the general ledger) is organized according to this equation, with debits on the left and credits on the right. For accurate reconciliation, the total debit balances must equal the total credit balances.
As we mentioned above, businesses usually enter transactions in the journal as they occur then transferred to the general ledger at the end of a financial period. However, like creating journal entries from transactions, some accounting firms have begun to automate the process of transferring journal entries to the general ledger.
How does a general ledger work?
Now that you have an understanding of where the data contained in a general ledger comes from and the principles that underlie how to record and organize that data, it’s time to take a look at what you’re able to do with your general ledger.
Once you’ve compiled all the transaction data from your journals and organized it into ledgers according to your chart of accounts, you’ll be able to:
- access an at-a-glance view of the general financial status of your business.
- generate a trial balance to ensure that debits and credits are equal, verifying the accuracy of your transaction records.
- easily file tax returns due to the accessibility of expense and revenue records.
- capture an accurate look at your revenue and expenses in order to make informed spending decisions.
- identify abnormal transactions and determine why they occurred.
- spot and stop fraud and, perhaps most importantly...
- quickly and easily compile the data necessary to create the three basic financial statements:
- income statements, which show how much money your company made and spent in a given period of time
- balance sheets, which show what your company owns and owes at a specific point in time
- the cash flow statement, which shows differences in how much cash is available, where it came from, and where it goes
The ability to generate the three basic financial statements is especially vital to your startup because, together, they’ll allow you to gain a clear picture of your business’s liquidity, profitability, and overall financial health.
How Zeni Can Help You Get The Most Out Of Your General Ledger
Thorough, accurate bookkeeping is imperative to the success of your startup, and the best way to ensure the thoroughness and accuracy of your books is to work with a professional finance firm.
With Zeni, you’ll have access to our team of top-tier finance experts, each with years of experience helping startups succeed. Our experts will help you set up and maintain your bookkeeping system, including creating a chart of accounts specifically tailored to your business so your general ledger most accurately reflects your business’s financial reality.
Additionally, Zeni’s accounting software utilizes cutting-edge AI and ML technologies to automate otherwise manual and error-prone bookkeeping tasks, ensuring that your journals, general ledger, and financial statements are all accurate and up to date—so you’ll never have to scramble to fix errors before preparing taxes or presenting to investors.
For first-time business owners, the ins and outs of accounting can be a lot to wrap your head around. And, due to the complexity and interrelatedness of many accounting concepts, it can be difficult to decide where to start.
