Why Use a General Ledger?
A general ledger is used to record every financial transaction made by an organization and serves as the basis for various types of financial reports. It provides details about finances such as cash flows, assets, liabilities, inventory, purchases, sales, gains, losses, and equity.
The general ledger also contains information used to calculate the financial performance of an organization. Understanding an organization’s finances is essential for creating budgets and business strategies, as well as for assessing the financial health of a business.
Does a General Ledger Use Double-Entry Bookkeeping?
Yes. Double-entry bookkeeping is the accounting method by which every financial transaction affects at least two accounts: a debit and credit account.
For instance, the purchase of a $2,000 computer would increase the business’s assets by $2,000 while decreasing its cash position by the same amount.
Incidentally, Pacioli popularized the vernacular Venetian terms “debere” (to owe) and “credere” (to entrust), from which debit and credit accounts get their names.
The accounting equation, sometimes called the balance-sheet equation, is the foundation of double-entry bookkeeping and is written as: “assets = liabilities + equity.”
What Are the Components of a General Ledger?
A general ledger can have any number of subledgers, sometimes also known as journals. Some of the most common types of subledgers include accounts payable, accounts receivable, cash, assets, expenses, and income.
The general ledger acts as a central depository for accounting information collected from subledgers, for example, stock, cash on hand, accounts receivable, customer deposits, accounts payable, etc.
The chart of accounts within a general ledger is usually divided into at least seven main categories: assets, liabilities, owner’s equity, revenue, expenses, gains, and losses. The chart of accounts acts as a directory for all types of transactions an organization has. Each category of accounts corresponds to different financial statements, for example:
Balance sheet (assets, liabilities, and equity).
Income statement (revenues, expenses, gains, and losses).
Are There Drawbacks to Using a General Ledger?
The general ledger serves a straightforward function: to record financial transactions throughout the lifespan of an organization. The general ledger can then be used to produce periodic financial statements. For those purposes, the general ledger accomplishes what it’s supposed to.
However, the general ledger also contains information about an organization’s past financial transactions and is used to produce financial statements that are backward-looking over a specific period, sometimes for year-over-year comparisons. That means the financial information, as well as the more detailed journal entries that feed into it, provide a picture of the past.
With its focus on past transactions, the information in a general ledger often reflects a point in time (month-end, quarter-end, or year-end). The timing of when information is posted to the general ledger and when the information is reported represents what “has” already happened and limits insight into what’s happening now or what might happen.
For these reasons, this limitation of a general ledger could hinder an organization’s agility or its ability to course correct or proactively take advantage of an opportunity before the month- or quarter-end. As businesses attempt to keep pace with the speed of change, the general ledger is of limited use when providing forward-looking insight and business strategies.
Also, as the purview of the finance function grows in complexity—to include seemingly disparate elements such as environmental, social, and governance (ESG), sustainability, talent and retention, financial planning and analysis (FP&A), enterprise resource planning (ERP), and value creation—the general ledger of yesteryear might not be adequate to track data and metrics that will be important in the future.