Recording transactions accurately is the foundation of good bookkeeping, helping you to minimise the risk of skewing figures and messing up tax returns as a result.
The thought of tax return errors is enough to reduce even the most battle-hardened accountant to wibbly jelly, so in this article we’ll explain what counts as a transaction, and how to record it. We’ll even include examples.
What is a transaction in accounting?
A ‘transaction’ is much more than a customer purchasing a product or service from you – it can be any business activity that impacts your business.
For example, your records might have transactions showing dividends paid to shareholders, loans you take from the bank and their subsequent repayments, the depreciating value of any business assets, payments on invoices, and more obvious ones like sales you make to your customers. It could even indicate something leaving your business, but not getting anything in exchange for it – such as a piece of equipment breaking down and being scrapped.
For example, you might create a sales invoice and record this transaction in your accounts to show goods or services you provide have been committed to a particular customer. Then, when they actually pay the invoice, you’ll show this transaction too. That way you know what has left your business, and whether or not you’ve been paid for providing it.
What types of transactions are there?
Transactions can happen as a result of all sorts of business activities, so it can sometimes be useful to think about them in terms of what they represent. This doesn’t necessarily affect the way you record them, but it can influence how you categorise them in your accounts. For example, business transactions show things that happen to keep the business running.
That way you can look at financial reports which show what is happening and in which area of the business, so it’s easier to identify problems and make decisions.
Business and non-business transactions
Think of business transactions as the things you need in order to keep your business operational. This could include the cost of renting office space, paying for computers you bought, or the money you spend on advertising.
For example
You run a business which sells paintings on Etsy. You pay rent and other utilities (like electricity, wi-fi, or water bills), and also buy supplies like paint, brushes, and canvases in order to make sales. They all count as business transactions.
Non-business transactions can refer to transactions which take place outside of normal business activities. For example, donations the business makes to charity.
Cash, non-cash and credit transactions
Cash transactions are probably the most common type of transaction, and indicate that something has been exchanged for cash, such as getting paid after selling a product or service. This doesn’t have to be physical cash despite how it may sound, so it can also include payments which take place through a payment handling platform, debit payments, or even a cheque.
They can indicate both something coming into the business, as well as something going out. For example, a customer buying a painting from you with their debit card is recorded as a cash transaction. The cash payment you made to your canvas supplier is also a cash transaction.
A non-cash transaction doesn’t involve the exchange of cash, but they should still be recorded in your financial statements because they impact the business’s ability to make a profit. Typical examples might include the depreciation of an asset which the business owns.
Credit transactions are different again because they indicate (you guessed it) a credit agreement. Some credit transactions can also include interest that must be paid on top of the original amount.
For example
You own a gym and a customer pays their yearly membership fee in twelve equal monthly instalments. This would be classed as a credit transaction.
Now let’s say you want to buy more exercise machines for the gym, so you take out a loan from a bank and pay it back over two years. The bank charges a 10% interest rate on the amount you borrowed. This would also be classed as a credit transaction.
Internal and external transactions
Internal transactions show financial activity taking place within the business without the involvement of any other third party. This could include things like employees’ salary payments. They’re not sales, but they do have an impact on the company’s finances, and show that funds have been supplied in exchange for labour. Hopefully, anyway.
External transactions are similar to a business transaction where there is a trade of goods or services for money. This could be between a customer and your business, or your business and a supplier, and so on.
Personal transactions
Your business might sometimes spend money on personal, non-business-related things, such as a birthday party, leaving do, or any other personal event. Just be aware that this might trigger all sorts of complicated rules about paying tax on benefits in kind though, so do your research first!
How do I record a transaction?
Obviously we’re going to say that recording transactions correctly is important. Partly because we make software that helps you do this, but mostly because it’s very, very important. The terminology makes it all sound horribly complicated though, which puts lots of people off the idea.
The most important thing is to record the details of every transaction which happens, such as the date it occurs, why it occurs, the amounts involved, where the transaction moves from and to… and so on!
Good bookkeeping software can automate most of your transactions, making record-keeping much easier! Check out our features and sign up to create your free Pandle account today.
