Tutorial

General ledger tutorial: GL basics and software options

Business application specialists in the IT department must take the time to understand how business is conducted in a given area. Likewise, business experts must collaborate with IT to automate processes correctly.

This tutorial covers the general ledger -- a key concept in accounting -- from both points of view.

How the general ledger works

Each activity in a company is posted to two accounts in the general ledger. One is a debit account and the other is a corresponding credit one. This is what allows the balance sheet to balance.

So, let's create some activities. We will assume that we are in the business of selling one size of widgets.

First, we borrow $100,000 from the bank.

Assets Liabilities
Cash Account Loans Outstanding
$100,000 (Debit) $100,000 (Credit)

In the balance sheet above, Cash is an asset account and Loans Outstanding is a liability account. Think of it as the things we accumulate and how we pay for them.

Now, we go out and buy 80,000 widgets for $1 each, paying $80,000 in cash. Here is what the balance sheet now looks like.

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Assets Liabilities
Cash Account Loans Outstanding
$20,000 (Debit) $100,000 (Credit)
Inventory  
$80,000 (Debit)  

A real customer shows up and agrees to buy 60,000 widgets for $2 per widget, bringing us revenue of $120,000. Revenue is an income account.

First, we record the revenue and cash that was received:

Assets Liabilities Income
Cash Account Loans Outstanding Revenue
$140,000 (Debit) $100,000 (Credit) $120,000 (Credit)
Inventory    
$80,000 (Debit)    

Revenue is another type of credit -- and the debits still equal the credits.

Now we have to make one last entry. We depleted the inventory by $60,000, and this will also affect the account of the cost of goods sold, which is also an Income account. Let's make these entries and review the financial statements.

Assets Liabilities Income
Cash Account Loans Outstanding Revenue
$140,000 (Debit) $100,000 (Credit) $120,000 (Credit)
Inventory   Cost of Goods Sold
$20,000 (Debit)   $60,000 (Debit)

The way accounting works is that you compute the net profit ($60,000) and move it to the Liabilities side of the balance sheet, in an entry called Shareholders' Equity.

Here is what the balance sheet looks like now:

Assets Liabilities Shareholder Equity
Cash Account Loans Outstanding Profit
$140,000 (Debit) $100,000 (Credit) $60,000 (Credit)
Inventory    
$20,000 (Debit)    

Now we have some real ownership in the company!

Where to find general ledger software

Although you can buy general ledger software by itself, it is often part of an accounting package that includes a larger set of offerings.

Accounts payable (AP) software keeps tracks of goods and services you have bought but haven't paid for yet. To a large extent, accounting is about cash management. If you pay your bills, say, within 60 days on average, you have the use of that cash for an extra 60 days.

Accounts receivable (AR) software keeps tracks of goods and services you have sold but haven't been paid for. Obviously, it's better to collect from customers faster than you pay your vendors. AR packages contain an aging program for grouping customers according to how late they are in paying you.

Cash and accounts receivable are called Current Assets and are relatively liquid. Software for managing long-term assets is also worth considering. For example, enterprise asset management (EAM) software keeps track of expensive fixed assets such as manufacturing and energy-generation equipment. With this class of asset, managing uptime is critical. EAM software is used to set maintenance scheduling and define how assets depreciate over time.

Numerous vendors offer accounting software. The low end, with products that cost less than $1,000, includes Sage and Peachtree, while the medium tier includes NetSuite and Microsoft, with the small business products in its Dynamics line. ERP vendors, among them SAP, Oracle and Infor, constitute the high end of accounting software and offer broad capabilities by industry.

Choosing general ledger software: Issues to consider

More on general ledger

Read a definition of general ledger

Understand how to merge general ledger software

Learn about accounts receivable-to-general ledger reconciliation

From a technology point of view, the underlying language of the accounting software won't matter: You won't want to change the source code. But the database could matter. Many accounting packages run on Microsoft SQL Server, a platform many companies have experience with. Indeed, most software packages used for financial reporting and business intelligence easily work with Microsoft SQL Server. A number of packages offer cloud versions that can provide a simple way to get started without having to maintain the software.

To examine products from a features and functions point of view, IT first has to develop a checklist with the finance department. Will it be creating a single general ledger or does it need the ability to consolidate across multiple ones? Will tools for AP, AR or EAM be needed? What about a report writer for closing financial statements?

Then there is ease of use. Consider taking a test drive to set up a chart of accounts, enter data and produce financial statements.

For IT professionals, understanding the business rules in a given department is crucial. It is equally important to understand how accounting software can help the company run more effectively and efficiently. Armed with this knowledge, IT can be a more effective business partner to the finance department.

About the author
Barry Wilderman has more than 30 years of experience as an industry analyst, researcher and consultant at such companies as META Group, Lawson Software, SalesOps Analytics, and McKinsey and Company. He is currently president of Wilderman Associates. Contact him at Barry@WildermanAssociates.com and on Twitter at @BarryWilderman.

This was first published in April 2013

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