In the field of payments and modern financial enterprises, the importance of accurate and reliable accounting systems cannot be overstated. Traditionally, a general ledger serves as a financial accounting system that provides companies with a comprehensive overview of their financial transactions.
However, modern financial companies that move money on a large scale need a more robust financial accounting system that provides a scalable, real-time overview of their cash movements.
It can be difficult to understand the difference between a general ledger and real-time accounting software, especially if you aren’t familiar with financial software. In this post, we define the two systems, explain the differences between real-time accounting software and traditional general ledger in banking and explain when your business needs one or the other.
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Table of contents
What is a general ledger software?
A general ledger software is a core accounting document that serves as a centralized repository for recording the financial transactions of a business or organization. It is essentially a complete record of all financial accounts and corresponding entries, providing a detailed overview of the financial activities of the company.
The general ledger software contains various accounts such as assets, liabilities, equity, revenues, and expenses. Each account represents a specific financial element, and transactions are recorded by debiting or crediting these accounts accordingly.
For example, when a company makes a sale, the revenue account is credited while the corresponding account, such as accounts receivable or cash, is debited.
The general ledger provides a comprehensive view of a company’s financial position and helps prepare financial statements such as the balance sheet, income statement, and cash flow statement.
It also helps analyze and track financial transactions, detect errors or discrepancies, and ensure accurate financial reporting.
Challenges of using the traditional general ledger software for financial service businesses
In the area of electronic money institutions (EMIs) and payment institutions (PIs), careful record-keeping is essential for recording and tracking financial transactions and balances. However, there are some challenges related to using the traditional general ledger accounting for EMIs and PIs.
Matching for balance
The main challenge of traditional general ledger accounting is that the total amount of money stored in the system’s internal wallets must always exactly equal the balance on the organization’s bank account. In particular, the sum of the balances on all the system’s internal wallets must always match the balance on the company bank account.
The broader range of functions
While payment institutions (PIs) operate in “gross” mode, i.e., pass payments sequentially from sender to receiver, focusing primarily on the execution of money transfers, e-money institutions (EMIs) have a broader range of functions. These include:
- issuing e-money,
- providing all payment services required by PSD2 for payment institutions,
- offering credit services, operational services,
- ancillary services such as currency exchange and storage.
The more complex functionality of e-money institutions leads to a more complicated structure for organizing money flows within the system. European legislation clearly stipulates that payment systems must meet certain regulatory conditions.
Failure to comply with these conditions may result in sanctions or even suspension of the payment system’s operations, following the PSD2 Directive.
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Automatic and real-time process
Incidentally, all technical processes in the EMI must run as quickly and fully automatically as possible, otherwise economic security risks may arise.
To monitor the balance of fiat money in the EMI bank account and issued electronic money, as well as obligations to third parties, payment companies should record all the credit and debit operations.
The traditional accounting system is based on the principles of the general ledger and double-entry bookkeeping, which were proposed in the 15th century.
However, the peculiarity of EMI activity is that all these operations may be complex business processes executed on a large scale in real-time.
As accounting tasks and technical implementation tools have evolved significantly, it may be worthwhile to investigate an accounting model more convenient than the general ledger, for use in electronic payment systems.
However, such a model should preserve similarity with the traditional double-entry accounting model.
The basics of the real-time accounting model
SDK.finance software has a top-notch architecture and design that allows for real-time accounting of cash flows in electronic payments.
This model meets the highest standards of economic security and is tailored to suit modern regulatory conditions. To ensure this, it uses the principle of splitting transactions.
The circulation of money within the system is carried out with the help of two main operations: split (dividing the amount into several amounts) and merge (merging several amounts into one).
Сompared to the general ledger accounting, where reconciliation is performed only after the transaction is executed, in SDK.finance such accounting is carried out in real-time with the automatic splitting of the transaction according to the flow intended for a particular business process.
To learn more about this approach, read the academic article on modeling cash flows in electronic payment systems in real-time.
The main advantages of real-time accounting
- Simple design – you can create and program business processes of any complexity, which are then automatically posted.
- Real-time execution – all transactions and reconciliations are executed in real-time
- Real-time accounting – the manual work traditionally performed by the accountant is fully automated by the system according to the designed and programmed business processes.
- the system is built in such a way that any transaction can be canceled, rewound, or postponed until a specific event or trigger at any point in its execution without affecting the accounting. In traditional accounting, you cannot cancel or terminate a transaction if it’s already recorded in the ledger.
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Key entities in the real-time accounting model
SDK.finance general ledger software robust architecture leverages the following key entities to manage transaction accounting operations effectively.
- Business process
The business process is an end-to-end operation from the business perspective, like account top-up, payment from an account, or transfer between accounts. Each business process contains a flow that represents the transaction sequence within the process.
Flow determines the rules for a business process and includes information about the business process type and in case of complex business processes – related processes, contract type, accounts involved, etc. It can be designed to reflect business processes of any complexity.
Transaction in SDK.finance is an atomic operation with 1 or 2 accounts of the same issuer. It has no status or flow because it is persisted within a single database transaction. Transactions form the building blocks of flows. They can be split and merged, allowing for flexible and adaptive accounting flows that align with your specific requirements.
As a result, the business process contains the flow, and within the flow, there is a transaction. Within each transaction, we can perform its “splitting” and/or “merging”, which allows us to create flexible and adaptable flows, which in turn can reflect business processes of any complexity.
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Types of business processes
Business processes can range from simple to highly complex and require accounting systems that can effectively process their transactions. Simple processes can be performed with a regular general ledger, while complex business processes can lead to general ledger failure.
Examples of complex business processes include:
- fund authorization,
- rolling reserve accounts,
- partner programs,
- transactions with anti-fraud checks.
To ensure control over the movement of funds in the payment system, each wallet in the system is considered a container that has similar properties to an object in programming. That is, it belongs to a certain class and is characterized by its own properties and behavior.
Wallets are divided into system and customer classes (with further subclass division), and their properties and behavior are determined by business logic.
How does the real-time accounting model work?
The real-time accounting model has emerged as a game-changer, revolutionizing the way companies manage their financial processes. With its ability to provide immediate insights, real-time accounting offers a variety of advantages over traditional accounting methods.
Below, we outline how the real-time accounting model works and how it helps companies stay agile and succeed in today’s dynamic marketplace.
- Verification of the final and output amounts after each split or merge operation is done programmatically at the software base function level to ensure compliance with the equations.
- The payment system database contains all intermediate information on the execution of transactions and allows effective control over the operation of the system, including the preservation of wallet history, and accurate reversal of transactions (rollover) with all associated fees and other benefits.
- The accounting system is completely similar to the traditional accounting model, as the final results of transactions can be represented as traditional entries.
- Split/merge notation, together with the container organization of fund accounting, allows for a precise description of payment transactions and the movement of payment funds of any complexity.
To understand how real-time accounting works let’s use an example of a basic simple Business process such as a funds transfer from the client 1 in-system account to the in-system account of client 2.
Explanation. In this case, we have a very simple Business process between three entities: client 1, client 2, and a system. This operation does not affect the circulation amount because money is already in the client’s in-system account and it was issued into circulation earlier and remains inside the system.
For example, the EMI plans to use the network of affiliates and has to pay a commission to each of them. The accountant has an idea of the affiliate reward amount, of how much the transaction commission will be, how much the commission for the card service provider will be, and in which direction this commission will go.
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With access to the SDK.finance general ledger software, developers can quickly design new business processes where all the business-specific rules are defined and the business process is programmed to automatically calculate, execute and record all technical transactions within the business process, including transfer of payment, extraction of commission to system commission account, extraction of affiliate reward to affiliate technical account, transfer of payment to the merchant, etc.
What is the difference between a real-time accounting model and a traditional general ledger?
A traditional general ledger is a financial accounting system that provides an overview of financial transactions after they have been executed (post-factum). In contrast, a real-time accounting model offers a scalable overview of cash movements within a financial enterprise in real time. It provides immediate insights and enables the automation of financial processes.
Why do modern financial companies need a more robust accounting system?
Modern financial companies that handle large-scale money transactions require a robust accounting system to track and manage their cash flows effectively. The complexity of electronic money institutions (EMIs) and payment institutions necessitates a more advanced system that can meet regulatory requirements, ensure economic security, and perform complex business processes in real time.
How does the real-time accounting model address the challenges faced by EMIs and payment institutions?
The real-time accounting model, as implemented in SDK.finance software, introduces the concept of splitting and merging transactions. This model allows for real-time accounting with the automatic splitting of transactions according to specific business processes. It ensures accurate tracking of balances, enables precise control over fund movements, and facilitates compliance with regulatory requirements.
What are the advantages of real-time accounting for EMIs or PIs?
The main advantages of real-time accounting are:
Simple design: Business processes can be created and programmed with any level of complexity, which are then automatically recorded.
Real-time execution: All transactions and reconciliations occur in real-time, providing immediate insights into cash movements.
Real-time accounting: Manual work traditionally performed by accountants is fully automated based on designed and programmed business processes.
Ability to rewind, undo, or cancel transactions: Transactions can be canceled, rewound, or postponed without affecting the accounting, offering flexibility and control.