A transaction is a completed agreement between a buyer and a seller to exchange goods, services, or financial assets. But in business bookkeeping, this plain definition can get complicated. A transaction will be recorded earlier or later depending on whether the company uses accrual accounting rather than cash accounting.
- The accrual accounting method requires a transaction to be recorded when it occurs, regardless of when the money is received or the expenses are paid.
- The cash accounting method records a transaction only when the money is received or the expenses are paid. This may require a letter of intent or a memorandum of understanding.
Accrual accounting is used by businesses with gross receipts above $1 million a year, while the cash accounting method is used by most small businesses.
Ray Dalio, HOW THE ECONOMIC MACHINE WORKS:
An economy is simply the sum of the transactions that make it up and a transaction is a very simple thing. You make transactions all the time. Every time you buy something you create a transaction. Each transaction consists of a buyer exchanging money or credit with a seller for goods, services or financial assets.
Credit spends just like money, so adding together the money spent and the amount of credit spent, you can know the total spending. The total amount of spending drives the economy. If you divide the amount spent by the quantity sold, you get the price. And that’s it. That’s a transaction. It is the building block of the economic machine.
All cycles and all forces in an economy are driven by transactions. So, if we can understand transactions, we can understand the whole economy. A market consists of all the buyers and all the sellers making transactions for the same thing.
For example, there is a wheat market, a car market, a stock market and markets for millions of things. An economy consists of all of the transactions in all of its markets. If you add up the total spending and the total quantity sold in all of the markets, you have everything you need to know to understand the economy. It’s just that simple.
People, businesses, banks and governments all engage in transactions the way I just described: exchanging money and credit for goods, services and financial assets. The biggest buyer and seller is the government, which consists of two important parts: a Central Government that collects taxes and spends money and a Central Bank, which is different from other buyers and sellers because it controls the amount of money and credit in the economy. It does this by influencing interest rates and printing new money. For these reasons, as we’ll see, the Central Bank is an important player in the flow of Credit.