Your business is the sum total of every transaction it makes and receives. But what exactly do we mean when we talk about a transaction?
In essence, a transaction is an agreement between two parties: a buyer and a seller. The seller supplies a product or a service in exchange for cash funds from the buyer. The more transactions a company makes, the more it is able to build operating cash flow, pay its debts, and turn a profit. Some transactions take place between a company and a private consumer (B2C transactions). However, a higher proportion of transactions are between businesses (B2B) where the company will act as a buyer rather than a seller. B2B transactions often have a much higher value than their B2C equivalent, and so the market is much larger. In fact, the B2B market in the US is 5 times the value of the B2C market.
As part of your company’s operating cash flow, there will be multiple transactions with third-party suppliers, from wholesalers to SaaS companies. B2B transactions encompass general operational costs, as well as capital expenditures like new equipment, machinery, or software that may make operations more effective.
Bookkeeping will log transactions differently depending on the accounting method used by the company, with funds being allocated to the correct account either during or after the time of the transaction.
Examples of transactions
Common examples of business transactions may include:
- selling your products or services to customers
- taking out a business loan from a bank
- paying your employees or outsourced subcontractors
- paying for the rent of a business property
- paying interest on the company’s liabilities
- moving current assets between departments
These transactions are usually categorized as follows:
Cash and credit transactions
Typically, payment for a transaction is due immediately as cash. This helps a company maintain liquidity. However, sometimes a company may extend credit to a customer to improve their brand value and take advantage of a sale the customer may otherwise miss.
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.
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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. Incoming funds are recorded as revenue and outgoing funds are recorded as liabilities. The simplicity of cash accounting makes it popular for smaller businesses.
The accrual method is slightly more complicated and is 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 creditor.
The IRS states that if an inventory is necessary to account for your company’s income, you must use an accrual method to account for purchases and sales.
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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 labor.