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What is a Business Transaction?
A business transaction is a financial transaction between two or more parties that involves the exchange of goods, money, or services. To engage in a business transaction, the business exchange must be measurable in monetary value so it can be recorded for accounting purposes. Business transactions will affect the financials of the company involved.
Business transactions can be as simple as a cash purchase or as complex as a long-term service contract . To be considered a business transaction, the following characteristics must be present:
- The transaction can be measured in monetary terms
- The transaction occurs between the business and a third party
- The transaction is on behalf of the business entity, and it is not for an individual purpose
- The transaction is recorded by authorized legitimate documents like an invoice, sale order, receipt, etc. that supports the transaction
A business transaction can occur between two parties for mutual benefits or between a business entity and a customer, such as a store and a person purchasing an item from the store.
To learn more, check out this article which provides a detailed definition of business transactions.
What is Not a Business Transaction?
Some events that occur during the daily operation of a business are not considered business transactions. The best way to determine whether an event is a legitimate business transaction is to consider how it would be entered into an accounting record. If there is no possible way to record the event for accounting purposes, it is not a business transaction.
Many businesses utilize a pro forma template or a pro forma financial statement to account for the company’s business transactions and forecast cash flow. To read more about pro forma templates, check out this article.
Types of Business Transactions
There are two ways to classify business transactions in accounting: cash and credit transactions or internal and external transactions.
Cash Transaction and Credit Transaction
- Cash Transaction: When a transaction is classified as a cash transaction, that means the payment was received or paid in cash at the time the transaction occurred. For example, if Mary purchases a new shirt from a store and pays at checkout, a cash transaction has happened between Mary and the store. Even though this transaction is called a “cash” transaction, even if the payment is made with a debit or credit card, it is still considered a cash transaction because the payment is made at the time the transaction occurs.
- Credit Transaction: In a credit transaction, the payment is made after a set amount of time, also called the credit period. For example, Mary wants to purchase a couch from a furniture store. Instead of paying at the time of the transaction, the store allows 30 days for payment. Cash is not involved at the time of sale, but Mary will be required to pay for the couch after the credit period of 30 days.
Internal Transaction and External Transaction
- Internal Transaction: When a business transaction occurs, and there is no external party involved, it is called an internal transaction. Even though there is no exchange in value with a third party, a monetary event has taken place that affects the business’s accounting. This can be in the form of depreciation on a fixed asset or loss of assets.
- External Transaction: External transactions are sometimes called exchange transactions and occur when two or more parties are involved in the transaction. Generally, these are daily occurring transactions like purchasing goods, paying rent or utilities, or paying employees.
If you are unsure if a financial transaction should be classified as a business transaction or which category of transaction the event falls into, it is best to consult with a business lawyer with a comprehensive understanding of small business law .
Examples of Business Transactions
Every day a business participates in multiple business transactions that affect the company’s accounting. Some examples of everyday business transactions include:
- Borrowing money from a bank: When a company takes out a loan from the bank through a loan agreement , the company is participating in a business transaction with the bank. The loan will affect the business’s assets account and liability account.
- Purchasing goods from a vendor: When a company purchases goods from a vendor, the transaction is between the company and the vendor. The company can record this transaction in a purchase account and vendor account. Purchasing goods will also need to be recorded in the company’s inventory.
- Paying rent and other utilities: When a company pays rent, electric, water, or internet bills, they complete business transactions. These payments will be recorded in the company’s assets and expense accounts.
- Sale of goods: If a company makes a sale, the company is entering a business transaction with the purchaser. The sale will be recorded in assets and income accounts. Typically, sales agreements are used to document the transaction.
- Paying interest: Interest paid is another form of a business transaction. This will affect the assets account and expense account of a business.
Some more specific examples of day-to-day business transactions often completed by companies include:
- Paying wages to employees
- Selling shares to an investor
- Purchasing insurance
- Repayment of a loan
- Paying taxes
- Purchasing a fixed asset
Read this article for more information about business transactions and examples.
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Features of a Business Transaction
To be considered a business transaction, the exchange must have these key features:
- The transaction must have financial value
- There must be two parties involved in the transaction
- The transaction is on behalf of the business entity, and it is not for an individual purpose
- The transaction is supported by a source document (an invoice, sale order, receipt, etc.)
If the transaction cannot be recorded in a business account, chances are, it is not a business transaction.
Business transactions must change the financial position of the business. This can happen in one of two ways: quantitative change or qualitative change .
Quantitative Change: A quantitative change occurs when the business’s value of assets and liabilities change. If a fire destroys a $10,000 piece of machinery, the company has faced a reduction in the value of assets. This is a business transaction because the loss can be recorded for accounting purposes.
Qualitative Change: A qualitative change occurs when different elements of assets or liabilities change. For example, if the company wishes to replace the machine they lost in the fire, the company will pay $10,000 for a new machine. The company losses $10,000 but gains a piece of equipment worth $10,000. The value of assets isn’t changing but the financial position of the company changes, so it is a business transaction.
Steps of a Business Transaction Analysis
After a business transaction takes place, it needs to be entered into a company’s accounts and analyzed. The five steps of the accounting cycle are as follows:
Step 1: Analyze and record the transactions as they occur
Step 2: Enter the transactions (debits and credits) in the general ledger
Step 3: Adjust the assets with a trial balance
Step 4: Prepare financial statements
Step 5: Close temporary accounts
It is crucial for a business to keep accurate up to date financial records. If your company needs help with analyzing business transactions, consider reaching out to a business lawyer or licensed CPA.
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