What Is the Relationship Between a General Ledger and Cash Flow?
A general ledger is the collection of all your business accounts. It summarizes the information you entered in your books of original entry such as sales, cash and purchases journals. You must transfer your transaction summaries from your journals to the general ledger so as to check for errors and balance your accounts. Cash flow, on the other hand, is the inward and outward movement of money as generated by your business activities.
The general ledger and the cash flow statement are both crucial in the dissemination of financial information for the accounting cycle, which is the chain of procedures you perform to account for all your business activities for a specific period. It is divided into 10 steps performed in the following order: transaction analysis, journalizing entries, general ledger, unadjusted trial balance, adjusting entries, adjusted trial balance, financial statements, closing of accounts, post-closing trial balance and reversing. You actually prepare the cash flow statement with the rest of the financial statements -- that is, income statement, balance sheet and statement of owner’s equity.
Considering that the cash flow statement is a reconciliation of the opening balances of your cash and cash equivalents, you must prepare it using the cash basis of accounting. If using cash basis accounting, you recognize revenue and expenses when you receive and pay out cash respectively. This is unlike the general ledger entries, which you must process further to convert them into accrual basis accounting.
Adjusting entries are used to convert general ledger entries into accrual basis accounting prior to preparing financial information. Accrual basis accounting requires you to recognize income when you earn it rather than when you receive pay for it. For example, you must recognize a credit sale as income once you write an invoice. Similarly, recognize expenses when you incur them rather than when you pay for them. For example, your prepaid rent remains an unrecognized expense until the rent becomes due.
Whereas the general ledger carries the entire list of your business accounts, the cash flow statement only stitches together information from relevant general ledger accounts into a detailed summary of the financial position of your business. Your cash flow information is contained in ledger accounts such as cash account, bank account, accounts payable, accounts receivable and owner’s equity account. You must piece together the transaction information in these accounts to generate your cash flows from operations, investing and financing activities.