Understanding The Importance of General Ledger in Business Accounting
In any major accounting audit, you hear about the ledger and how it unlocks insights. The journal entries are called the building blocks, and the general ledger is called the backbone of a company’s financial infrastructure. It is because the general ledger provides you with access to a detailed list of all transactions that occurred in a specific category during a particular period. The closing balance of the ledger account is the amount recorded in the financial statements.
Understanding General Ledger with an Example
Let’s take the example of Assets. You report $100,000 in Assets on the balance sheet. But how you arrived at this figure is answered by the general ledger of Assets. The Assets ledger account contains details of all assets purchased and sold, carried forward, and depreciated during a specific period. Like this, there are general ledgers for Liabilities, Revenue, Expenses, and Equity. The general ledger helps the auditor cross-check figures and verify transactions.
This is just one of the many reasons why the general ledger is important in accounting. Once you understand the importance of this ledger, you can use it optimally to make decisions, create financial statements, and prepare tax returns.
How a Transaction Flows from General Ledger to Financial Statements
To understand the importance of the General Ledger, you first have to know its place in the record-keeping system.
1. A business transaction involves the movement of money, either immediately or in the future. This includes purchase, sale, loans, investments, and more.
2. Each transaction generates a supporting document, such as an invoice, receipt, contract, or bank statement.
3. Journal entries: The bookkeeper uses those documents to record transactions. with debits and credits, as per the standard accounting principles and the chart of accounts. These accounts are actually broad categories under which different transactions fall. Five major ledger accounts are Assets, Liabilities, Revenue, Expenses, and Equity, each with a unique identification number (UIN), such as 1000 for Assets. Depending on your business, you may have sub-categories for segments that have too many transactions. For instance, a retailer might have Accounts Receivable and Inventory as subsidiary accounts under the main Assets account, with UINs1100 and 1200.
The journal entries have equal debits and credits. Suppose you are recording a cash sale of $100; the journal entry will be
Cash Debited $100
Sales Credited $100
4. Posting to the general ledger: Journal entries are then transferred to the respective general ledger, in the debit or credit side, as stated in the journal entry. If we were to record the above example of a cash sale in the Revenue ledger, $100 would be recorded in the credit side as Cash. In this way, all sales (credit and cash) during the month will be recorded in the Revenue ledger. A corresponding debit-side entry will be recorded in the Cash sub-Ledger of the main Asset ledger.
5. Preparing the trial balance and financial statements: At the end of the month, debits and credits will be adjusted to arrive at the closing balances of each ledger account. This balance will be used to prepare a trial balance. The accountant will use the trial balance to prepare the financial statements (income statement, cash flow statement, and balance sheet).
Now that you know how a transaction flows, it’s time to understand how to make the most of the ledger.
Reasons Why the General Ledger Is Important in Accounting
A financial statement provides a snapshot of the company’s financial situation, but a general ledger helps accountants and business owners track the movement of each line item in the financial statement.
1. Access Details of All Transactions: A general ledger is a collection of all entries of a particular type of financial transaction. You have a control account that holds all subsidiary ledger accounts. The asset account will be the control account for subsidiary accounts – Cash, Accounts Receivable, and Inventory. The general ledger will also include a chart of accounts, a list of all Control and Subsidiary accounts. The general ledger makes it easy to access details of all transactions. Some data models can link transaction details to information about customers, orders, and inventory, making it easy to track transactions and make informed decisions about future ones.
2. Comprehensive Financial View: You can use a general ledger system to get a comprehensive financial view of your business. Suppose the balance sheet shows a steady increase in accounts receivable. You set a threshold; if receivables breach it, it’s time to act. The general ledger will provide you with details of parties who have pending payments with the transaction date. You can identify late payors and decide on whether to escalate the payment recovery method.
3. Decision-Making: The transaction details in the general ledger can help a business identify areas of opportunity and financial vulnerabilities and devise strategies. For instance, John is Mary’s biggest client, and he has been reducing his orders. Mary can look into the Revenue ledger or create a separate sub-ledger for John to identify any trends, such as payment delays or changes in order volume in a particular month. She can connect with the client to understand the reason for the dip and offer solutions such as a flexible payment structure or cross-sell other products that could boost their off-season sales.
4. Balancing Books: The general ledger is not only important to a business owner, but also to an accountant to prepare financial statements and balance books. If the balance sheet doesn’t tally, the accountant will cross-check numbers with the ledger.
5. Filing Taxes: The general ledger closing balance for each month can help you make rough calculations around your tax liability and forecast future tax liability. This can help you pay taxes on time. A well-maintained ledger system can make annual tax filing smooth.
6. Identifying Fraud and Ensuring Compliance: Since journal and ledger entries are recorded using supporting documents, any fraudulent transactions can be identified by studying the trend. An auditor can trace a suspicious transaction back to the general ledger and identify the source of fraud. Business owners can act accordingly by putting in place necessary checks or tightening loose ends.
Contact Edelkoort Smethurst CPAs LLP in Burlington to Help You with Your Bookkeeping and Accounting Needs
Talk to a professional bookkeeper to help you set up the general ledger system and record transactions accurately. At Edelkoort Smethurst CPAs LLP, our accountants and bookkeepers can provide services such as preparing general ledgers, financial statements, and tax filing. To learn more about how Edelkoort Smethurst CPAs LLP can provide you with the best bookkeeping and accounting services, contact us online or by telephone at 905-517-2297.
