Small business accounting is complicated. Transactions are occurring left and right, yet you’re supposed to keep track of every single one of them. If only there was a document that contained a complete record of your business’s financial history. Whenever you needed information about an outstanding liability or a past account receivable, all you would have to do is consult this document.
Your wish has been granted in the form of a general ledger.
Keeping tabs on finances is an essential requirement for business growth. A general ledger makes it much, much easier to do just that. This guide will explain what a general ledger is and why they are so important for small businesses.
A general ledger is a business’s main accounting record, dating back to its first day in business. While other financial documents might contain a year or a month’s worth of transactions, a general ledger contains all transactions made over your company’s lifetime.
In other words, when a transaction takes place, it goes into your general ledger. This information can therefore be used to create financial statements, perform internal audits, and earn approval for small business loans.
Most general ledgers feature accounts from seven different categories. Here they are:
As you can see, the first three items on this list are also the first three items on your balance sheet. Accounts that fall under these three categories are therefore known as balance sheet accounts. The four other items on the list are found on your income statement. Hence, they are known as income statement accounts.
Larger businesses typically have over one hundred different accounts between the two sections due to the many types of transactions that take place.
General ledgers utilize an accounting method known as “double-entry,” in which each account has a debit section and a credit section. The name “double entry” refers to the act of recording every transaction into one account’s debit section and at least one other account’s credit section. One account falls under the balance sheet category, while the other falls under the income statement category.
Enter a transaction into the debit section when you:
Enter a transaction into the credit section when you:
Your business has just bought $10,000 worth of inventory via credit card. Since your inventory asset increased in value, you’d enter $10,000 into the debit section of your “Inventory” account. And because you used a credit card, you’d enter $10,000 into the credit section of your “Accounts Payable” account.
Another example could be the purchase of a $2,000 laptop for an employee. You’d make a debit entry of $2,000 into your income statement’s “Expenses” account and a credit entry of $2,000 into your balance sheet’s “Cash” account.
Double-entry accounting is confusing when it comes to revenue. For instance, let’s say your business has just recorded sales revenue of $200. In this case, you would make a debit entry of $200 into your balance sheet’s “Cash” account and a credit entry of $200 into your income statement’s “Revenue” account.
The unrivaled importance of staying on top of your finances should illustrate the value of a general ledger. It’s nearly impossible to run a business without one. Here are a few reasons your general ledger may be the most useful resource for business owners:
You may look at a financial statement and notice a figure that seems incorrect. Checking for possible mistakes in data entry is as simple as reviewing your general ledger. For example, you might find that a bill for one monthly expense was accidentally posted to the account for a different monthly expense.
The ability to quickly correct mistakes on financial statements is also crucial for tax preparation. Come tax season, you’ll be able to give your accountant the guarantee that your books are absolutely flawless.
Business owners are often advised to refrain from mixing personal and business bank accounts. But let’s be honest: Plenty of successful business owners have deposited personal funds into business bank accounts for one reason or another. Maybe they were trying to cover expenses or impress a business lender by showing “skin in the game.”
A general ledger keeps track of personal deposits without recording them as income. Odds are, every business owner is going to have to mix personal and business funds at some point. The many risks of this inevitability are only avoidable with the help of a general ledger.
If a general ledger seems complicated, it’s only because business expenses are the same way. For example, it’s very difficult to track an ongoing expense with interest attached. You might make the same payment every month, but the amount you pay in interest changes.
Thanks to a general ledger, you can put the interest in a separate account to determine when it’s time to negotiate a better rate or possibly a balance transfer.
Many business owners view general ledgers as the solution to any discrepancies in their financial statements or bank accounts. And that’s just fine. You don’t have to regularly review your general ledger as long as you review financial statements at least once per month.
Once you have your general ledger software set up, you’ll soon discover that losing track of your finances is one dangerous habit you don’t have to worry about.
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