Every business comprises different activities, leading to revenue generation and sustaining the business’s existence. And a business transaction is the backbone of almost every business activity.
A business transaction is an economic event involving a third party that is documented in an organization’s accounting system. In this blog, we’ll go through the concept of business transactions and some examples in elaboration.
What is a Business Transaction?
Business transactions are defined as events occurring with any third party, measurable in monetary terms, and having a financial effect on the business. Getting insurance from an insurer, purchasing inventory from a supplier, selling items to a client in cash or on credit, paying employees’ salaries, getting a loan from a lender, and selling shares to an investor are some examples of business transactions.
For instance, a manufacturing company needs to buy raw materials to be used to produce finished goods. So, it will enter into a transaction with the vendor, which will have a monetary value. This will affect the company’s financials.
Moreover, business transactions are supported by the permitted, and genuine documents relating to the event or transaction entered. For example, in the case of a sale, the sale order and invoice will be regarded as legal documents for proving the deal.
Importance of Business Transaction
Business transactions are recurring and thus might occur once a year or more frequently in a company. If there isn’t a transaction in a company, the company is considered not functioning and will eventually shut down. Therefore, having business transactions suggests that an entity is active.
For example, if a company stops paying taxes, it can be interpreted as having no presence in the country, lacking ample resources to pay taxes, or having some other reasons.
Moreover, a small number of transactions indicates that a business is functioning, whereas a large number of transactions indicates that a business is expanding. These business transactions may be related to more competitive business practices and engagement with a business’s external and internal environments. So, active business transactions indicate the status of a company.
For example, if a company keeps buying fixed assets, such as large machinery, warehouses, office spaces, and so on, it suggests it is planning to expand. On the other hand, business transactions like salaries to staff, loan repayment, and rent payment suggest that the company is running smoothly, regardless of expansion.
Business transactions are usually documented. This way, anyone can assess the company’s ability to do business and generate profits throughout the relevant period. Moreover, recording business transactions aids in separating the income derived from business operations from other income sources, including capital gains, lottery winnings, salary income, etc.
Final accounts are generated through them at year’s end or for a specific period. So, business transactions enable the assessee to properly segment their income and expenses into the right heads and record and file his income tax returns in accordance with legal requirements.
What Are the Types of Business Transactions?
Cash Transaction: A cash transaction is one in which the money is made or received when the contract is made.
For instance, you pay ₹10,000 as your house rent in cash. Since a cash payment is made at the moment of the transaction, this is a cash transaction. On the same lines, if you spend ₹2,000 in cash to purchase stationery, it is also a cash transaction.
Credit Transaction: Unlike cash transactions, cash is not involved in credit transactions at the moment of the transaction. Instead, the amount is paid afterward (termed as credit period).
Suppose you sell art and craft supplies and an art school is one of your clients. At the beginning of a new academic session, the school asks for a 30-day credit period while buying art supplies in bulk from you on a credit basis. Therefore, there is no cash exchanged at the time of sale in this transaction. Rather, the consumer (the art school) will pay the amount after the 30-day credit period.
Internal Transaction: An internal transaction does not involve any outside parties. These transactions don’t include a value exchange with another party but have monetary terms or worth, such as fixed asset impairment.
Examples of internal transactions include:
- Depreciation of a fixed asset.
- The loss of property by fire.
- The provision of products to other business units.
For example, as per the IT act, the depreciation rate for a laptop is 40% per year. Thus, the depreciation of every laptop is recorded in the books of accounts. (Note that depreciation is documented as an operating expense. And, every expense is a business transaction.)External Transaction: A transaction involving two or more parties is referred to as an external transaction. They are daily routine transactions, such as paying for purchases, sales, rent, utility costs, etc.
Examples of Business Transactions
A firm engages in several transactions each day that have an impact on its accounting. Typical commercial transactions include:
Taking out a loan from a bank: When a corporation enters into a loan agreement, it engages in a business transaction with the bank. The loan will impact the company’s asset and liabilities accounts.
Buying products from a vendor: When a business buys products from a vendor, the transaction is solely between the two parties. The business can record this transaction in a vendor account and a purchasing account. Additionally, purchases must be noted in the company’s inventory.
Rent and other utility payments: A business completes processes when it pays its rent, electric, water, or internet bills. The assets and spending accounts of the business will be updated with these payments.
Sales of goods: When a business makes a sale, it engages in commerce with the customer. The transaction will be noted in the records for assets and income. Sales agreements are typically used to formalize the deal.Interest payments: Making interest payments is a type of business transaction. This will impact a business’s assets account and expense account.
Conclusion
As business transactions offer an abstract perspective of the interactions between firms to attain a business objective, they are becoming more and more significant. A business can accurately portray its finances and thus assure the accuracy of its financial statements by recording business transactions, giving it a record of every business activity.
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