Why You Need to Use a General Ledger for Your Business
Your business’ product is superb. You have a great plan. You have funding. But if you don’t understand how to keep the books, none of that might matter.
What is a general ledger?
A general ledger is the master account book for a company. It uses a double-entry system of accounting and serves as a database of all the financial transactions your business conducts. Keeping accurate records and knowing how to interpret the data is a vital way of taking the pulse of your company. A well-kept ledger provides insight to where and how the money is coming in and where it is going out.
As a business owner, you can look at the financial statements the ledger generates to determine if you can start taking a salary or if you can afford to give your workers a raise. It enables you to determine if you’re spending the way you want to be spending, if you’re spending too much fancy office supplies or if money is disappearing into an unscrupulous employee’s pocket.
Common general ledger terms
Here are some common terms you’ll come across when putting together your business ledger.
- Accounts. For a business, the term “account” is used to categorize expenses. Accounts can be designated for expenses like rent, inventory and utilities.
- Single-entry system. In this less commonly used system, you enter transactions once. You can use this simple system if you have a young business that’s not complex, but has numerous weaknesses and does not scale up.
- Double-entry system. This is a commonly used accounting system in which you enter all transactions twice, as a debit and a credit.
- Current assets. This equals cash plus any other assets you can convert to cash within a year.
- Fixed assets. These are items you own that you regularly use for the business operation and that you typically don’t sell, such as buildings and equipment.
- Balance sheet. This report shows the business’ assets, liability and equity.
- Income statement: This shows a company’s performance over a specified period, including profit or loss.
- Cash flow statement. This is a summary of the cash and cash equivalents (investments you can convert to cash immediately) coming into and going out of the business.
The four main parts of a ledger
- Debits. Debit entries increase an asset or expense account and decrease a liability or equity account. In double-entry accounting, you use the term “debit” for increases in expenses, assets and dividends.
- Credits. These increase a liability or equity account and decrease an asset or expense account. In double-entry accounting, you use the term “credit” for increases in liabilities, income and capital.
- Assets. Assets are things of value the company owns, such as cash, accounts receivable and inventory.
- Liabilities. These are the amounts that the company owes, such as notes payable, accounts payable and salaries payable.
How to read a ledger
Each account gets its own page in the ledger. Account names will vary depending on your business’ particular expenses and how your finances are set up, but that means that expense categories — such as rent, utilities and inventory — will each get their own pages.
Reading a line of the ledger from left to right, the first column represents the date for each transaction. The next one is a description of the transaction. Next, you’ll see two columns for transaction amounts. Debits go in the left column and credits go in the next column to the right. The final column on the right is for the running balance — it might also appear at the bottom of the sheet.
As an example transaction entry, here is how a rent payment would look. In the rent expense account ledger:
This is the corresponding entry in the cash account ledger:
Note that debits are sometimes abbreviated as “dr.” and credits are abbreviated as “cr.”
The basic accounting equation
The basis of double entry accounting, the accounting equation is also known as the balance sheet formula.
The accounting equation is:
Assets = Liabilities + Equity
This equation simply balances out the company’s assets (such as the bank account, a computer system) with the total amount of liabilities (like unpaid bills, loans from the bank) and the equity, or what is owned by the business owner.
Using the balance sheet you generate from your ledger, you can show that all uses of capital (assets) equal all sources of capital (debt and equity).
The double-entry accounting method is the one accountants have used since the days when they logged transactions by hand.
For each transaction, you make entries to two accounts: one debit and one credit. You use debit for increases in expenses, assets and dividends, and you use credit for increases in liabilities, income and capital.
So, if you want to record a $1,000 sale, you enter a debit to the cash account and a credit to the revenue account. They balance each other out, and because it has to balance, error detection is built in.
Single-entry accounting, also called single-entry bookkeeping, is a simple, but not ideal, method that’s similar to how some people track their personal finances. Picture using the register in a checkbook.
You can use this method to track accounts of cash, tax-deductible expenses and taxable income. On a line in the log, you enter an expense (“$45”) in the expenses column with a brief description (“office supplies”). A customer makes a purchase, so you make a deposit in your checking and log that on the next line in the revenue column (“$25”, “1 widget”).
Single-entry accounting could work for a solopreneur operating a simple and very small business as a sole proprietorship, but it doesn’t scale up, and it is not going to work for a business with any complexity. With single-entry, you can’t log other accounts like inventory, and you can’t generate a balance sheet.
The general ledger represents the big picture. But before you put them into the ledger, you enter transactions daily into journals — in chronological order and in more detail. A journal entry will state the date, which accounts it affects and the amounts. The most common types of journals are:
- Sales — credit sales transactions
- Purchase — credit purchases for the business
- Cash receipts — cash received
- Cash payments — cash going out
What it all means for the small business owner
How much accounting does an entrepreneur really need to know? “What I would like to see a [new] business do is talk to your CPA and get set up correctly, then they have to decide who’s going to put their data into their database,” said Maxine Stern, a volunteer for the small business-mentoring organization SCORE who also has an accounting background. “It needs attention every month.”
Stern says someone in charge at the business should know their way around the financials, but then they can outsource the data entry maintenance while continuing to check in. Someone who charges less than a CPA, such as a bookkeeper, a staff member or even the owner can enter the transactions.
Most owners don’t want to do it themselves, Stern said, but if you want to take on that responsibility, make sure you have a good understanding of the business financials. If you choose to outsource this, check in regularly at least each month, Stern said.
“Say to the bookkeeper, ‘What does this mean? What’s this category? Why did it come out that way?’” she said. You don’t need to love the ledger, but you should understand it. It’s an essential tool for informed owners to monitor their businesses.