Financial Transaction Meaning
A financial transaction is a communication or an agreement between buyers and sellers to exchange assets, services, or goods in return for money. It involves at least one asset, for example, money or any valuable item like silver or gold.
A transaction causes the finances of a minimum of two individuals or organizations to change. By recording all transactions impacting a business’s liabilities and assets, the stakeholders can keep themselves updated regarding changes in the organization’s performance and financial position. There are four types of financial transactions — purchases, payments, receipts, and sales.
Table of contents
- Financial transaction definition refers to a completed agreement between a buyer and a seller to exchange financial assets, goods, or services for payment. Such a transaction changes the finances of two organizations or individuals.
- The four types of financial transactions are purchases, sales, payments, and receipts. Businesses use the accrual or cash method of accounting to record such transactions.
- Financial transactions in accounting are always bidirectional, unlike non-financial transactions.
- Countries like Belgium, Finland, and Colombia levy a financial transaction tax to achieve specific objectives, such as more equitable and fair tax collection and suppressing the volatility in financial markets.
Financial Transaction Explained
Financial transaction definition refers to a business event that has a monetary effect on at least two entities’ financial statements. Both parties record the transaction as an entry in their accounting records. Organizations or individuals may record transactions earlier or later based on whether they use cash or accrual accounting.
In the financial world, transactions managed by a financial transaction manager can be complex as organizations may agree to make a deal today, but the settlement might take place on a future date. Or, there could be expenses or revenue yet to be due. Furthermore, third-party transactions may also complicate the procedure.
The use choice of accrual or cash method of accounting to record transactions impacts an organization’s tax and financial reporting. When using the former method, a business must record a transaction when it occurs, irrespective of when it pays the expenses or receives money. On the contrary, when businesses use the cash method, they only record transactions when they receive money or pay expenses. Organizations may require a memorandum of understanding or a letter of intent in this case.
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Let us understand the different types of financial transactions managed by a financial transaction manager in detail.
- Payments: Such transactions involve an entity paying another entity for goods and services.
- Receipts: These transactions occur when organizations receive money for providing goods and services to another organization.
- Sales: Sales are transactions involving the legal transfer of property for credit or money. These are a part of businesses’ income when delivering goods or providing customer services. Organizations record sales transactions performed by extending credit to customers as accounts receivables.
- Purchases: In the case of these transactions, businesses obtain the goods or services required to make sales. Organizations may make purchases using accounts provided by the entity supplying the goods or services. Alternatively, they can use cash to purchase goods and services. Organizations record these transactions in accounts payable of the statement of financial transaction.
The recording of financial transaction in accounting is an important step in the accounting process of any business organization. This is done to maintain accurate and transparent financial records in the financial transaction worksheet, that can be used for future reference, financial and other types of decision making and also for audit purpose. The steps for the same are as follows.
- Identify transactions – This is the first step where the transactions are identified for recording. Thye may be related to purchase, sale, loans investments, capital expenditure, etc.
- Gather documents– This is very important because these documents support the transactions made and is the very basis of transparency that should be maintained in every transaction.
- Accounting using double-entry system – Every transaction entered in the books has two sides, a debit and a credit. Both affect different types of accounts, but it is the foundation of accounting system where journal entries are used for recording. Total of both the sides should be equal, ensuring the accounting equation, which is assets = liability + equity, is balanced. Each entry is recorded in appropriate accounts.
- Preparation of general ledger – All the entries recorded are then transferred to the general ledger of the statement of financial transaction, which is a total record of all transactions. It summarizes the entire financial activity of the business.
- Preparation of Trial Balance – Trail balance ensures that both debit and credit are balanced. In case they don’t, the trail balance helps in identifying errors and rectifiying them.
- Financial statement preparation – Here is the final step where the income statement, balance sheet and cash flow statement are made using the transactions recorded in the accounting books. It provides information about the financial condition of the company.
- Auditing – The auditing process ensures that the transactions recorded are clear, transparent and correct. It also ensures that the recording method is as per the regulations and accounting standards. This helps the management gain trust and faith of stakeholders who use the financial statements for decision making.
Thus, financial transaction recording ensures proper tax compliance and reporting too. This is crucial for further growth and expansion of the business.
Let us look at these financial transaction worksheet examples to understand the concept better.
Suppose Jacob purchased a watch from a store and completed payment via cash at checkout. This is a financial transaction using the cash method of accounting, as the store recorded the transaction at the time of receiving the payment.
In November 2022, The Internal Revenue Service or IRS shared tips for the forthcoming tax season. In addition, the federal tax agency gave a reminder regarding the $600 threshold for receiving Form 1099-K for third-party payments. This change applies to payments received from third-party networks, for example, PayPal or Venmo, for transactions involving the sale of goods or side jobs per the IRS.
Previously, the federal Form 1099-K reporting threshold was worth over $20,000 for taxpayers with more than 200 transactions. That said, Congress reduced the limit as part of the American Rescue Plan Act of 2021. So now, a single transaction worth over $600 may trigger the form.
Financial Transaction Tax (FTT)
FTT is a tax levy on a particular financial transaction in accounting for a specific purpose. This tax is expected for transactions involving intangible assets in the financial sector. Typically, it does not include any consumption tax paid by consumers. The purpose of imposing this tax is as follows:
- Curbing the volatility associated with financial markets
- Equitable and fair tax collection
- Suppressing speculation while ensuring not to discourage hedging
The following are some countries that levy FTT:
- United Kingdom
Financial Transaction Vs Non-Financial Transaction
Individuals new to the financial world must learn to distinguish between these two types of transactions. So, let us look at the distinct vital characteristics of the two concepts in detail.
|Financial Transaction||Non-Financial Transaction|
|It involves transferring money or valuable items like gold or silver from one account to another.||In this case, the transfer of funds does not occur. Moreover, such a transaction does not impact an account’s balance.|
|An organization purchasing inventory from another organization by paying cash is an example of this transaction.||Balance inquiry and change of user details are two examples.|
|Such transactions are never unidirectional.||These transactions can be unidirectional.|
Frequently Asked Questions (FAQs)
It is any device or instrument representing a financial account that one can utilize to procure property, goods, services, cash, or make payments.
The most basic method of recording a transaction is a journal entry. It involves accountants manually entering debits, credits, and account numbers for every transaction. This approach is subject to error. Moreover, it is very time-consuming. Hence, accountants usually use this method for notable entries and adjustments.
The time taken to transfer money depends on the customer’s risk profile — a new customer might face delay when transferring substantial funds. Also, if an individual has a history of being overdrawn, banks or other financial institutions may take time to release the funds. Another factor that may cause a delay is the time of fund transfer. For instance, delays might happen when one transfers funds during the weekend or on bank holidays.
A nation’s Gross Domestic Product or GDP does not include financial transactions as they represent a transfer of ownership instead of production or current income.
This article has been a guide to Financial Transaction and its meaning. We explain the tax system, along with examples, types & recording process. You may also find some useful articles here –