Knowing the Importance of Ledgers in Your Business Bookkeeping

Ledgers are commonplace in the accounting process and they can sound a bit tedious. Worse, you might imagine a thick, dusty book filled with numbers you don’t understand. After all, the definition of a ledger is

“A book containing various financial accounts of various transactions and of various types.”

But don’t be afraid. In this article, we’ll outline important information to help you understand what a general ledger is and why it’s important to your business finances. We will also cover information such as:

  • What is it used for
  • Why do you need it?

Having a good understanding of the general ledger will allow you to use it as a tool in your business to make smarter, healthier and better financial decisions.

So let’s start with the basics.

Table of Contents

1 What is a Ledger?
1.1 The five main categories/accounts that make up the general ledger are:
1.2 Importance of Double Entry Bookkeeping
1.3 Types of accounts in the general ledger
1.4 Processes in the accounting cycle
2 What Are Ledgers Used For?
2.1 That doesn’t mean you have to be a financial expert or an accounting expert

What is a Ledger?

In accounting terms, the General Ledger serves as the basis of a company’s accounting system. Individuals and businesses working in finance use this tool to closely track all accounts and transactions throughout the entire operational life of the company. So it can be said that this tool is a collection or main record of accounts that summarize all transactions that occur in a business entity.

Basically, this tool is used to collect financial data of a business to prepare financial reports and reports for tax time and so on. If you use accounting software, this is done automatically in the software.

The five main categories/accounts that make up the ledger are:

1. Assets: any resources owned by the business and that generate value
2. Liabilities: current or future financial debts owed by the business
3. Equity: the difference between the value of the assets and liabilities of the business
4. Income: income earned from the sale of business products and/or services
5. Expenses: money paid by a business in exchange for a product or service

The chart of accounts lists all the accounts in the general ledger, which of course can number in the thousands for a large business.

Remember, general ledger accounts are not budget accounts. They show the actual amount spent or received and not just projected in the budget.

Importance of Double Entry Bookkeeping

You’ve probably heard of double-entry bookkeeping before, and it’s an excellent record-keeping method for your small business.

Double-entry bookkeeping allows you to ensure that the general ledger is always in balance. The entered financial transaction is debited from one account and credited from another in the same amount. It also helps ensure that you never overestimate your business financially.

It also ensures that the accounting equation remains in perfect balance: Assets = Liabilities + Equity

Similar to a personal checkbook, the credit and debit amounts of the general ledger must always balance. It contains account information about the company throughout its life and is mandatory for compiling financial statements and reports such as balance sheets and income statements.

Types of accounts in the general ledger

  1. Bought Ledger
  2. Sales Ledger
  3. General Ledger
  4. Private Ledger

In general, the general ledger contains the accounts that correspond to the income statement and balance sheet for which it is intended.

The revenue section of the income statement can include totals from the general ledger accounts for cash, inventory and accounts receivable – money owed to a business – sometimes broken down into departments such as sales and service and related expenses. The expense side of the income statement may be based on a GL account for interest costs and advertising costs.

Other accounts summarize transactions for categories of assets, such as plant and equipment, and liabilities, such as accounts payable and notes payable, or loans.

Additionally, other accounts can be used to track specific categories, perform useful calculations or summarize groups of accounts. The latter type is called a control account.

For example, an accountant might use a T-account – so named because of its T shape – to track only the debits and credits in a particular general ledger account.

Processes in the accounting cycle

Following the rules of double-entry bookkeeping, each entry in the book must appear in two places: once as a debit and one as a corresponding credit. And the two added together must equal zero.

The terms debit and credit do not have the usual meanings, and whether each adds or subtracts from the total account depends on the type of account. For example, debiting an income account causes it to increase, while the same action on an expense account causes it to decrease.

What Are Ledgers Used For?

Ledgers have great responsibilities. After all, it stores all the account information needed to prepare your company’s financial statements.

Previously we discussed accounts payable and accounts receivable, among other accounting provisions. However, these accounting items play only a small part in understanding a company’s complete financial picture.

The general ledger takes monthly summaries of these journals to create one “big picture”.

As noted above, data extracted from the general ledger is used to create other types of financial statements, such as a balance sheet or income statement. That way you can grow a successful and sustainable business which means that you are in tune with the financial well-being of your business.

That doesn’t mean you have to be a financial expert or an accounting expert

However, what it means is that you need to understand the basic accounting terms, financial statements, and income statements quite clearly. Understanding these basics not only allows you to make smarter business decisions, but you’re in a better position when you know exactly where the health of your company is in relation to potential investments and business decisions based on your business financial data.

Here are 5 super important reasons why your small business needs a ledger:

1. This tool will provide accurate records of all financial transactions.
2. This tool will make filing taxes much easier because you contain all your income and expense data in one place in a clear and detailed way.
3. This tool will help you easily view and monitor all transactions.
4. This tool helps compile key financial reports that are essential for evaluating the financial standing of your business.
5. This tool helps you identify and prevent fraud.

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