What is a general ledger

What is a general ledger? The general ledger is the backbone of any accounting system which holds financial data for an organization.

Until the 1970s and 1980s, recording entries manually in big ledger books, was the way to go! You would have separate subledger books, such as payroll, cash, inventory, receivables, and many others depending on the type of company. From each of these subledger books, summary amounts would be transferred manually into a central place called the general ledger. As you can imagine, due to the manual nature of the process, this process is prone to errors like writing 51 instead of 15.

Today’s enterprise resource planning systems are a lot less manual, and the closing cycle tends to be a lot faster, but the general idea of subledgers and general ledger is still the same. For example, in an ERP system like SAP, original documents are registered in the accounts receivable subledger by customer account, and in the accounts payable subledger by vendor account. The amounts posted in the subledger are then transferred from the subledger to accounts in the general ledger. Subledgers generally hold a lot more detail than the general ledger.

Compared to the manual process of recording entries, computerized systems have the advantage of validation rules that can prevent a user from posting if a journal entry is not balanced. This can save a lot of time “downstream” in the accounting process.

Here’s how that process works all the way from recording individual transactions to preparing financial statements. Transactions based on source documents are recorded in the appropriate subledger (payroll, cash, inventory, receivables, payables, fixed assets, etcetera). The subledger activity is then posted as debits and credits to the appropriate accounts in the general ledger. The listing of the account names is called the chart of accounts. Getting a transaction into the general ledger can be done through a subledger, but also through a manual journal entry directly into the general ledger. The extraction of account balances is called a trial balance. The purpose of the trial balance is to ensure that the value of all the debit value balances equal the total of all the credit value balances, and that the individual balances per account or per group of accounts makes sense.

If an error is found in the trial balance, the finance team goes through a process to rectify errors. Some of these errors may be very easy to correct, others might take a substantial amount of analysis. Is there an error in the general ledger itself? Is there an error in how the data from the subledger is posted in the general ledger? Or is there an error in how the data was recorded in the subledger, or any of the manual journal entries? Or in the source documents themselves? Find the error, and correct it.

Once the trial balance is deemed accurate, the next step in the process can be taken: preparing the financial statements (income statement, balance sheet, cash flow statement). Using the financial statements, you can connect the financial numbers to the operational reality, by calculating financial ratios and analyzing the trends.

The general ledger is the backbone of any accounting system. It is the central repository for accounting data transferred from all subledgers. Now that you understand how the general ledger works, you having taken another step to master #accountingbasics

Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business and #accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!