General ledger: What it is and how it works

What is a general ledger?

Since the dawn of time—or at least the dawn of modern-day business—general ledgers have been around to summarize the financial states of businesses of all sizes. Simply put, a general ledger, also called a GL or a general journal, is a categorized list of every business transaction. But before computers and software became go-to tools for business owners, a general ledger was actually, well, a ledger.

That’s right: picture a big book that was filled with hand-written transactions and their details. Date, type, amount, balance. All that recording, all that math… all done manually.

Sounds a bit…wrist-crampingly, mind-numbingly painful, doesn’t it?

Don’t worry. Thankfully, GLs have had a serious upgrade. Keep reading to find out how they work, why they’re so important for small business accounting, and the components that make a general ledger so useful for business owners.

‍But first, a TLDR:

• General ledgers, also called GLs, are used in accounting, usually with the double-entry method

• General ledgers record and categorize financial data, like day-to-day business transactions, and are then used to create a business’s financial statements

• GLs can include a lot of transactions, so account codes are used to keep everything extra organized

• Transactions are organized into four key categories or as some call it, “sub-ledgers”: assets, liabilities, revenues, expenses, and owner’s equity

• General ledgers are critical for small businesses because they’re needed for accurate financial statements, tax time, and to keep organized
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Now that we’ve got the quick facts covered, let’s dive deep into general ledgers and how your business can benefit from them.

How do general ledgers work?

General ledgers are used in accounting, usually with the double-entry method. Sound familiar? That’s the accounting system that records your business transactions in at least two accounts: debits and credits.

General ledgers are used to track and record, not predict or budget. They show the actual amounts of money that have been spent or received by a business. This gives an accurate view of the financial status and happenings of a business.

Now, when it comes to the recording, a general ledger item is categorized into four key parts:

• A journal entry: this describes the item number of the transaction that’s been posted to the account

• A description: this provides more detail about the transaction

• A debit or credit value: this is for the net balance change

• ‍A resulting balance: this is provided after the credit or debit is posted
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During bookkeeping, you’ll end up tracking other records that aren’t part of your general ledger. These are called journals or daybooks.

Journal transactions are used to enter business activity that doesn't involve money changing hands, like recording a non-cash expense, like depreciation, or making period-end adjustments. Your GL is used to bring together all the accounting entries for each business transaction that’s occurred. It orders it by date and posts it in its respective account.

So, what happens to the totals that are calculated in your general ledger? Simple. They’re brought into other financial reports, like the balance sheet. As a reminder, a balance sheet is like a financial report card. The amounts in them are permanent amounts, giving you an overview of your business’s financial health at any given time.

But for now, let’s stick to general ledgers. (P.S. You can read more about balance sheets here.)

Why are general ledgers important for small business accounting?

General ledgers are kind of big deals—especially for small business accounting. Here’s what we mean:

1. For your financial statements

As a small business owner, you’re likely familiar with financial statements like balance sheets, income statements, and cash flow statements. All of these statements are built on the data that’s recorded in the general ledger.

Without the GL, you don’t have the three main statements we mentioned above. And if you do? Well, they’re probably not too accurate.

2. For your taxes

Your GL is what you or your accountant need to file your taxes. It gives a record of all of your financial transactions throughout the year, which is exactly what your accountant needs for filing.

In addition, your GL will be used by your accountant as they do their detective work. They’ll use it to spot any fraudulent or unusual transactions.

3. For all-in-one-place recording

Every financial transaction that you record is called a journal entry, and those journal entries are kept in your general ledger. This means everything from bank statements to invoices are kept in one place, so you, your accountant, or your business partner don’t have to search other statements or records to put the pieces together.

Components of a general ledger

A general ledger is made up of four central components of a general ledger. Here’s a breakdown of each.

General ledger accounts

We briefly mentioned general ledger accounts in the sections above, but let’s double check on them.

When you’re doing your bookkeeping outside of your general ledger, you’re likely recording in something called a journal or a daybook. These are what’s used to record your transactions by date, and can include things like payments against invoices and their totals. These then get recorded in your general ledger.

Depending on how your GL is organized, this might be categorized into something called subledger. A subledger is a detailed record of transactions related to a particular financial account, like inventory or payroll.

Debits and credits

Debits and credits are key parts of modern-day accounting systems—especially in relation to the double-entry method, which records every transaction into two accounts: a debit to one and a credit to another.

Their purpose is to ensure balance. So, for each transaction, the total debit amount has to equal the total credits. Think of it as checks and balances. Less errors and better, more accurate data.

Account balances

Account balances represent the overall value in an account, calculating the debits and credits at any given time.

When looking at account balances, you might hear the terms debit balance and credit balance. If the debits of the account exceed credits, that’s a debit balance. Likewise, if credits exceed debits, the account has a credit balance.

All of this is crucial for the financial statements of a business to make sure that your recorded balances match up with other records, like bank statements. This process is called reconciliation, and should happen periodically to avoid errors.

Chart of accounts

A chart of accounts (also called a CoA) is like a financial filing system for businesses. Essentially, it’s the framework for all of the financial accounts, organizing and classifying transactions.

It works hand-in-hand with the GL, which actually records the transactions. Here, the CoA acts as the set-up and structure and the GL holds the details.

What are general ledger accounts?

General ledger accounts are the categories that your general ledger is organized by. It’s also called sub-ledgers, which are like the notebooks you use to record your transactions as they occur. All of those transactions are then transferred into your “master notebook,” which—you guessed it—is your general ledger.

Here are a few examples of the types of general ledger accounts.

Asset accounts

Asset accounts are comprised of the resources your business owns that will have value in the future. This includes cash, inventory, owned equipment, and real estate, just to name a few.

Liability accounts

Liability accounts in a general ledger are the obligations or debts that your business owes, like loans or accounts payable, for instance.

Equity accounts

Equity accounts show details in ownership interest of your business’s shareholders. Common stock, retained earnings, and additional paid-in capital are just three of the typical types of equity accounts in a GL.

Operating revenue accounts

Operating revenue accounts show the income that you’ve generated through your main operations. These accounts can help show which business activities drive the most (or least) earnings.

Operating expense accounts

Operating expense accounts document every cost that’s needed for running your business. Things like payroll, rent, and depreciation are types of operating expense accounts.

Non-operating revenue accounts

Non-operating revenue accounts are the money that’s earned by any business outside of main operations. This could be investment income, or money that you earn from selling equipment that you no longer need.

Non-operating expense and loss accounts

Non-operating expenses are your business expenses that aren’t related to  your core operations. Think of interest payments or one-time losses that could be a result of missing or overcharged inventory.

General ledger example

To help you get a better understanding of general ledgers, here’s an example of one from our favorite hypothetical businesses: Wishbone Dog Cookies.

Here’s a breakdown of how this works:

On the left, you’ll see a column for the date. That’s when the transaction was made. One column over to the right is the journey entry number. You’ll associate this with the journal entry number that you’ve associated with the transaction.

Next is the description, giving details behind the transaction. In the case of Wishbone Dog Cookies, the first two descriptions are for cash payments made for cookie orders. Because the account is receiving money, that goes into the debit column.

But remember that double-entry method? This means that there will be another ledger for Wishbone’s accounts receivable. This account will reflect a credit reduction for the same amount as orders 01 and 02 because Wishbone no longer has that money owed by the customer.

And since the goal is for balance, one asset account must increase while another decreases by the same amount, and vice versa. This will all be reflected in the balance category, which you’ll see on the far right side of the chart.

General ledger FAQs

Does a general ledger use double-entry bookkeeping?

Yes, a general ledger uses double-entry bookkeeping… that is, if the business owner also uses that process to organize and record their financial data. Double-entry bookkeeping is when each transaction appears in two columns: the debit column and the credit column. These totals must always balance.

What is general ledger reconciliation?

General ledger reconciliation is the process of periodically verifying the accuracy of financial records. This occurs by comparing data in the general ledger to other supporting documents or records.

More specifically, general ledger reconciliation involves checking transactions, balances, and entries in the general ledger against external sources such as bank statements, invoices, receipts.

The goal of this process is to make sure that the balances and transactions that are recorded in the general ledger actually reflect the financial activities of the business.

What are trial balances?

Trial balances are a financial tool specific to double-entry bookkeeping. They’re prepared regularly to make sure everything is correct before all of your financial statements are created.

Ultimately, the trial balance adds up all of the business’s debits and credits for a specific period to make sure everything matches up. If it doesn’t you’ll have to make the necessary changes and then create an “adjusted trial balance.” Use that version to create your financial statements.

In relation to your general ledger, the trial balance document exists separately. That said, it’s not its own report. Think of it as a way to ensure all of your ingredients are correct before you start making the cake and put the cherry on top!

The bottom line on general ledgers

General ledgers are a key part of small business accounting. They summarize all of your business’s financial information and lists every accounting transaction all-in-one place.

However, doing it all manually is a lot of work. And like we mentioned earlier, these days, doing it manually doesn’t have to be your only option for record keeping.

So throw away that giant journal before it collects piles of dust! Account software like Wave’s exists to make bookkeeping—and all of the record-keeping and double-entry parts of it—easy.

And more accurate.

And much less heavy. (Both physically and metaphorically.) 📚💪