How to Construct a General Ledger for Your Small Business
Building The Most Important Accounting Record For Your Business
The general ledger is a complete record of all financial transactions made over the lifetime of your company. The phrase "keeping the books" refers to maintaining a general ledger, the main accounting record for your business if you use double-entry bookkeeping. It's the primary tool that allows you to keep track of all transactions and sort them into subcategories so you—and your accountant—can find a comprehensive, summarized record of your business finances all in one place.
What Is a General Ledger?
The general ledger is the foundation and core document of your accounting system.
It is created from the accounting journal entries you have made. Accounting journal entries are made for every financial transaction your firm undertakes and are made in chronological order. The general ledger takes the entries of the financial transactions from the accounting journal, stated in debits and credits, and breaks up the entries into their separate accounts.
Each entry belongs to one of five different accounts that come from your Chart of Accounts: assets, liabilities, expenses, revenue, and equity.
You may also have sub-accounts on your Chart of Accounts and general ledger depending on the size and complexity of your firm.
Why a General Ledger Is Important
The general ledger serves several functions in the financial operation of your business. Think of it as a catch-all bucket. It holds all the financial information you'll use to create the financial statements for your firm and it is based on a source document, along with at least one journal entry for each financial transaction. A source document can be something like an invoice or a canceled check that shows you paid the receipt.
Here are five reasons that the general ledger is so important for your business:
- Loan application: Lenders will invariably ask for a variety of financial records if your business applies for a loan. Your general ledger can help you immediately locate and pinpoint whatever information you need.
- Balancing your books: A general ledger lets you arrive at a trial balance. This assists you in balancing your books.
- Preparing for an audit: If you are audited by the Internal Revenue Service (IRS), it will be easy to prepare for the audit since your financial records are all in one place.
- Fraud: It allows you to more easily spot fraud or any other issue with your books since it is easy to look through and understand.
- Internal and external communication: The general ledger has all the information necessary to generate your financial statements for both internal, or management, use and external, or investor or customer use.
General Journal vs. General Ledger
The general journal and general ledger are used by those firms that use double-entry accounting as the best record of their financial transactions. The two major differences between the general journal and general ledger in a business firm are that the general journal is the first place a financial transaction is recorded by a business.
A financial transaction is recorded in the general journal in chronological order. When the financial transactions are transferred to the general ledger, they are recorded on an account-by-account basis.
If each account balances, so will your financial statements when you develop them at the end of whatever time period you have established. From these documents, you can develop your financial statements by conforming to the accounting equation.
The general ledger sometimes has sub-ledgers usually for these four accounts: sales journal, purchases journal, cash receipts journal, and cash disbursement journal.
How to Create a General Ledger
Here is an example of a general ledger:
Here are the steps you should take to set up the general ledger:
1) Create the General Ledger Accounts
There are five accounts that are relevant to the general ledger in a form similar to that in the table above. They are the assets, liabilities, equity, revenues, and expenses accounts. Create a table like the one above for each account.
2) Transfer the Transactions From the General Journal
Transfer the financial transactions from the general journal to the appropriate accounts on the general ledger with all their detail.
3) Number the Transactions
Under the "number" column, put the number of the journal transaction on the general ledger account. That allows for cross-referencing.
4) Debits and Credits
Debit and credit the appropriate accounts.
Keep a running balance of the debits and credits so you can determine if the account will balance when you have entered all the transactions.
The general ledger then becomes the master financial document for your business with columns for the name of the transaction, debits and credits, and the dollar amount, along with a running balance.
Today, there is a number of accounting software packages that allow journal transactions to be easily transferred into the general ledger accounts.
Example of a General Ledger
Your business is an ongoing small business. For example, on January 2, 2021, say you buy $4,000 worth of inventory with cash. Here is the general ledger entry with the corresponding journal entry.
Keep in mind that debit and credit amounts seem counterintuitive on the surface. Assets, which are a plus, have a debit balance. If you deplete other assets, or if you add liability or equity, those transactions are credits.