Transaction - What is a transaction?
A transaction in the business world refers to any event that can have an impact on the finances of the companies involved.
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While the term ‘transaction’ can take on a number of different meanings (depending on the context and the field in which it’s being used), the most commonly understood meaning is that of a financial exchange - in other words, the trade of a product or service for money.
Any transaction typically involves two parties: a buyer and a seller. This is, of course, the simplest form of a transaction.
There are several characteristics that can help easily identify a business transaction. These include:
An exchange that represents a clear amount of cash (something that can be evaluated as having a decisive cash value)
The issuing of a document related to the transaction (for example, an invoice, payment receipt, etc.)
A resulting action in the accounting of the business(es) involved (in double-entry bookkeeping, an entry in the appropriate credits and debits)
However, business transactions can also involve more than just goods or services and cash. They can become infinitely more complex when involving the exchange of other elements of cash value, such as:
Assets - the purchase or sale of items considered assets to the business (either tangible or intangible assets)
Liabilities - the collecting of accounts receivable, for example
Bank accounts - not necessarily a business transaction, but the movement of funds within a bank account can be considered transactions
Recording a transaction differs depending on the accounting method that has been selected for your business. This means that it’s affected by whether you’re using cash accounting or accrual accounting.
For most freelancers, sole traders, and small businesses, cash accounting is the method most often chosen. This is fairly straightforward as it involves recording a transaction when the cash or payment is actually collected from the customer.
In this approach, even if a service is completed in September, if the payment comes through in October, this is added to the accounts in October.
More commonly used by larger businesses with a significant annual turnover, accrual accounting means that a transaction is recorded when the products or service is delivered or completed (as opposed to when the payment is collected).
In accrual accounting, if the same service is completed in September, the transaction will be recorded in September, even if the payment is actually received in October.