What is a Transaction?
A transaction is an agreement between two parties: a buyer and a seller. In a transaction, the seller supplies goods, services or other financial assets in exchange for cash funds. Financial transactions are the lifeblood of a company, helping them to build a steady stream of revenue and facilitating cash flow. As well as transactions between the business and its customers (B2C transactions), there will be many instances where the company will act as a buyer rather than a seller. A company’s operating cash flow includes numerous transactions with third-party vendors.
These may supply the goods that the company sells wholesale, or components/ingredients of products that the company makes. Alternatively, they may sell software or other goods and services required for business operations, known as B2B transactions. These cover general operational costs, as well as capital expenditures such as new equipment, machinery or plant that could enhance operations.
In business bookkeeping, it’s important to record different types of transactions accurately to ensure financial transparency. This plain definition of “transaction” can get tricky. Depending on whether the company uses cash accounting or accrual accounting, a transaction may be recorded earlier or later.
Examples of transactions
There are many exchanges that take place in business operations that meet the definition of a transaction. Some of the most common may include:
- selling products or services to customers
- borrowing start-up capital or bridging finance from a bank
- paying employees, contractors, or subcontractors
- paying for rent and utilities on a business premises
- paying interest on the company’s liabilities
- moving current assets from one department to another
These transactions are usually categorised as follows:
Cash and credit transactions
Typically, payment for a transaction is due immediately as cash. This helps companies maintain liquidity. However, sometimes a company may extend credit to a customer to improve their brand value and take advantage of a sale they may otherwise miss out on.
Internal and external transactions
Most transactions are external, meaning they take place between the company and third parties such as customers and suppliers. However, some transactions are internal such as the exchange of assets between departments or locations, or the payment of employees.
Business and investment transactions
As well as transactions related to business operations, a company may also make investments in marketable securities and other assets to generate income.
Accounting for business transactions
There are two bookkeeping systems used to account for business transactions: cash accounting and accrual accounting.
The cash accounting method records transactions only when cash is received or paid by the company. Where funds are incoming they are recorded as revenue and outgoing funds are recorded as liabilities. The simplicity of cash accounting makes it popular for smaller businesses. In the UK, HMRC dictates that a company can only use this accounting system if their revenue is below £150,000.
The accrual method is slightly more complicated and often used by businesses with greater turnover. Here, revenues are recorded when they are earned, even if payment has yet to be received. Liabilities are also recorded when invoices are received and not necessarily when funds are transferred to the debtor.
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Frequently asked questions about transactions
What is a double-entry?
A double-entry system is a bookkeeping method where every transaction results in a credit to one account, and a debit to another. It is used to help prevent accounting errors and ensure that the company’s books are properly balanced.
What is an internal transaction?
An internal transaction involves the exchange of assets and funds within the business. For instance, the payment of employees is an internal transaction because funds are paid to an individual within the company in exchange for their labour.
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