What Are Accounting Transactions? (Definition and Examples)
From purchasing supplies and selling products and services to borrowing money from a creditor, account transactions occur in business every day. Every company uses various transactions, and it may be your job to keep track of them. If you work in finance, understanding these transactions is important because they affect a company's financial status and statements. In this article, we define accounting transactions, explain the different types, and share common examples to help you identify these transactions more easily.
What are accounting transactions?
Accounting transactions are any business activities that affect the company's financial statements and status. Essentially, any exchange of money is an accounting transaction. Companies document these transactions in a number of ways, such as spreadsheets or invoices, to keep track of their finances. Here are some examples of these transactions:
receiving cash or credit from a customer for selling them a product or service
borrowing funds from a creditor
purchasing products from a supplier
investing in another business
paying off borrowed funds
paying employees their salary
Types of account transactions
Here are the most common types of account transactions:
An external transaction, also known as a business transaction, is a trade of goods and services for money. One party is buying a product or service while the other party is selling it. This transaction can be between two people, two organizations, or a person and an organization. For example, a customer purchasing a hammer from a hardware store or a business purchasing equipment from a supplier are external transactions.
An internal transaction is any financial activity that occurs within an organization rather than with a third party. It is typically an exchange of finances between departments or the company and its employees. Internal transactions aren't sales like external transactions are, but they affect the company's finances. An employee receiving their salary or a department giving office supplies to another department are examples of internal transaction.
Cash transactions are one of the most common types of transactions that businesses make. They refer to any transaction that involves the exchange of cash. It doesn't have to be physical money, it can include debit transactions or cheques as well. A cash transaction is a type of external transaction, so an example is a restaurant purchasing ingredients from their supplier and paying them in cash. Another example is a customer purchasing a coffee from a cafe and paying with their debit card.
A non-cash transaction is any type of financial transaction that doesn't involve the exchange of cash or credit. Businesses still record these transactions in their financial statements as they impact the company's income or expenditure. An example of a non-cash transaction is a company that takes over a loan from another company in exchange for an asset, such as a share. Another example of a non-cash transaction is a company converting their bonds to another type of asset of equal value.
Credit transactions occur when a creditor or lender supplies a company with goods, services, money, or securities in exchange for a deferred payment. Both parties agree to a payment plan, which typically includes a date the borrower needs to complete their payment. Some credit transactions include interest the borrower needs to pay on top of the original amount they borrowed.
An example of a credit transaction is a customer purchasing a bed from a mattress store and paying for their purchase every month for 18 months, rather than paying the total amount upfront. Another example is a business taking out a loan from a bank and paying it back over five years while also paying a 10% interest rate.
Business transactions are day-to-day transactions that companies make to keep the business running. This can include sales and purchases, such as the external transactions we discussed, but also rent for office space, money spent on advertising, and other expenses. An example of a business transaction is a company hiring an external consultant to improve their marketing strategies. Another example of a business transaction is a company buying new kitchen equipment for their restaurant.
Non-business transactions are transactions that companies make that don't involve a sale or purchase, such as giving donations or fulfilling social responsibilities. A company hosting a charity event and donating the money they make is an example of a non-business transaction. Another example of a non-business transaction is a company sending their employees to volunteer for a cause instead of working for a day.
Personal transactions occur when employees or businesses spend money for personal reasons. For example, a department throwing a birthday party for one of their employees is a personal transaction. Some companies require employees to pay for their own personal transactions, while others offer a certain amount of money for personal use.
Ways to record these transactions
If you work in the finance department, you may be responsible for recording and monitoring the business' accounting transactions. There are typically procedures and processes laid out by the senior management team. If you're working for a startup or trying to make the existing processes more efficient, here are some ways you can do so:
Journal entries: This is the most common method of recording transactions, as you simply need to enter the debit or credit for each transaction in a journal. It can be a physical journal or ledger, but many companies use digital versions to streamline the accounting process.
Issuance of an invoice: Using accounting software, you can automatically create journal entries whenever you issue an invoice to a customer. Include relevant information, such as the price of the product or service you sold, the unit quantity, and any sales tax. Then, send this invoice to your customers and the information will go to the company's accounts receivable account.
Receipt of an invoice: Similarly, when you receive an invoice from a supplier or another business, record this information in an expense or accounts payable account. Keep a copy of both types of invoices for your own records.
Issuance of paychecks: As paying employees is a large, reoccurring expense, it's important to keep track of the issuance of these paychecks. Enter the employees' pay rates, hours worked, and deductions in a payroll account.
Types of financial statements
To record the different transactions your company makes, you may use one of the following financial statements:
An income statement is a report of an organization's financial performance for a specific period, such as a quarter or a year. It displays the business' sales, then deducts expenses to determine how much the company earned or lost that period. If the income shows a positive number, that is the business' net profit. If it shows a negative number, that is the loss they incurred from spending more than they were earning.
Income statements are useful for the business to keep up with their finances and create a budget and sales plan that helps increase profit. Income statements are also useful for investors interested in a business because they can see how well the company is doing.
A balance sheet, also known as a statement of net worth or a statement of financial position, reports a business' financial position as it displays the company's liabilities, assets, and shareholders' equity. It displays what a company owns and owes, and the amount shareholders have invested in it. It follows an equation that states the company's assets are equal to its liabilities and shareholders' equity.
Statement of cash flows
Cash flow statements outline how cash is inflowing and outflowing during a reporting period. Businesses typically separate their cash flow statements into three categories, operating activities, investing activities, and financing activities. This allows businesses to see the changes in their cash balance from the beginning to the end of a particular period.
Statement of changes in equity
Changes in equity statement are less common, but they report the changes in a business' equity during the reporting period. This can include the purchase of shares, the dividends issued, and any other profits or losses the company has. This statement is more commonly used externally than the other financial statements, as it's of more interest to shareholders.