Every account that is on your chart of accounts will be included in your general ledger, which should be set up in the same order as the chart of accounts. While the general ledger does not include every single accounting entry in a given period, it does reflect a summary of all transactions made.

If your business is small and cash-based, you can set up much of your general ledger out of your checkbook. The checkbook includes several pieces of information vital to the general ledger-cumulative cash balance, date of the entry, amount of the entry and purpose of the entry. However, if you plan to sell and buy on account as most businesses do, a checkbook alone will not suffice as a log for general ledger transactions. And even for a cash-based business, a checkbook cannot be your sole source for establishing a balance sheet.

An important component of any general ledger is source documents. Two examples of source documents are copies of invoices to customers and from suppliers. Source documents are critical in that they provide an audit trail in case you or someone else has to go back and study financial transactions made in your business. For instance, a customer might claim that he never received an invoice from you. Your source document will prove otherwise. And your source documents are a required component for your accountant at tax time. Other examples of source documents include canceled checks, utility bills, payroll tax records and loan statements.

All general ledger entries are double entries. And that makes sense, because for every financial transaction in your business, the money (or commitment to pay) goes from one place to another. For instance, when you write your payroll checks, the money flows out of your payroll account (cash) into the hands of your employees (an expense). When you sell goods on account, you record a sale (income) but must have a journal entry to make sure you collect that account later (an account receivable).

The system used in recording entries on a general ledger is called a system of debits and credits. In fact, if you can gain even a basic understanding of debits and credits, you will be well on your way to understanding your entire accounting system.

As outlined above, for every debit, there should be an equal and offsetting credit. It is when the debits and credits are not equal or do not offset that your books don't balance. A key advantage of any automated bookkeeping system is that it will police your debit-and-credit entries as they are made, making it far more difficult not to balance. It won't take many 3 a.m. error-finding sessions in a manual system to persuade you to automate your bookkeeping system!

All debits and credits either increase or decrease an account balance. These basic relationships are summarized as follows:

Account TypeDebitCredit
AssetsIncreasesDecreases
LiabilityDecreasesIncreases
Stockholder's EquityDecreasesIncreases
IncomeDecreasesIncreases
ExpenseIncreasesDecreases

In a general ledger, debits always go on the left and credits always go on the right.

While many double entries are made directly to the general ledger, it is necessary to maintain subledgers for a number of accounts in which there is regular activity. The information is then taken in a summary format from the subledgers and transferred to the general ledger. Subledgers showing cash receipts and cash disbursements are pretty easy to follow. However, some subledgers, such as accounts receivable, inventory, fixed assets, accounts payable and payroll can prove to be a challenge in their daily maintenance.

Excerpted from Start Your Own Business: The Only Start-Up Book You'll Ever Need, by Rieva Lesonsky and the Staff of Entrepreneur Magazine, © 1998 Entrepreneur Press