Every business undertakes several transactions during the course of its operations. Transactions are those business events that have an impact on the finances of the business and are thus recorded in its books of accounts.
This article looks at meaning of and differences between two different types of transactions based on how they are settled – cash transaction and credit transaction.
Definitions and meanings
A cash transaction is a business transaction that involves exchange of cash at the time of occurrence of the transaction itself. Cash in this case implies settlement – the settlement may be in actual cash, by credit or debit cards, check payment or bank transfer but would still qualify as a cash transaction if they are settled at the time of occurrence of the transaction itself.
Any business transaction can qualify as a cash transaction if it involves immediate settlement in cash. For example, over the counter sale of goods involves exchange of goods for cash at the time of the sale transaction itself thus qualifies as a cash transaction. This transaction would qualify as cash transaction irrespective of whether it is paid for by cash or by a debit or credit card.
Cash transactions are recorded in books of accounts in both cash basis and accrual basis of accounting. These transactions have an immediate effect on the cash flow of the business.
A credit transaction is a business transaction which although has monetary impact does not involve exchange of cash at the time of occurrence of the transaction, but is settled in cash at a subsequent date.
Credit transactions result in creation of asset (receivable) or liability (payable) in the books of accounts. This asset or liability is extinguished from the books at the time of settlement.
For example, a manufacturer sells his goods to a wholesaler who does not pay for them immediately but is allowed a credit period of 30 days for making payment. This is a credit sale of goods that does not involve immediate cash exchange however it results in recognition of income and creation of a debtor, thus it still has monetary impact and qualifies as a credit transaction.
Credit transactions are only recorded in books of accounts maintained on accrual basis. These are recorded in books maintained on cash basis only at the time of settlement.
Difference between cash transaction and credit transaction:
The difference between cash transaction and credit transaction has been detailed below:
- A cash transaction is a business transaction that is settled with immediate exchange of cash.
- A credit transaction is a business transaction which is not settled in cash at the time of entering into the transaction but is settled at a subsequent date.
2. Timing of settlement
- Cash transactions are settled immediately.
- Credit transactions are settled subsequent to the transaction at a later date.
3. Applicable to which basis of accounting
- Cash transactions are recorded under both cash basis and mercantile basis accounting.
- Credit transactions are only recorded in mercantile basis accounting.
4. Entries per transaction
- Cash transactions can be recorded through fewer entries as they impact cash or bank immediately.
- Credit transactions are recorded through multiple entries – creation of asset/liability at the time of the transaction and separate entries at the time of settlement.
5. Impact on cash flow
- Cash transactions have immediate impact on cash flow.
- Credit transactions do not have immediate impact on cash flow.
6. Impact on balance sheet
- Cash transactions impact the balance sheet through changes in the cash or bank account.
- Credit transactions impact the balance sheet by creation of an asset (receivable) or liability (payable).
7. Suitability to business types
- Cash transactions are generally found in greater numbers in smaller businesses where value of transactions is lower. Cash transactions are also more prevalent in retail business where although volume and value of transactions are higher, they are generally immediately settled in cash.
- Credit transactions are more prevalent in larger businesses where system of credit period is followed.
- Cash transactions can include over the counter sale of goods, retail purchases etc.
- Credit transactions include accrual of utility bills which can be paid subsequently, sale and purchase of goods on credit basis etc.
Cash transaction versus credit transaction – tabular comparison
A tabular comparison of cash transaction and credit transaction is given below:
|Business transaction that is immediately settled in cash||Business transaction that is settled in cash at a future date|
|Timing of settlement|
|Immediate||At a date subsequent to transaction date|
|Applicable in which method of accounting|
|Cash basis and mercantile basis||Only to accrual basis|
|Entries per transaction|
|Fewer can be even single||Multiple|
|Impact on cash flow|
|Has impact||No impact|
|Impact on balance sheet|
|Through cash or bank account||Creation of asset (receivable) of liability (payable)|
|Suitability to business types|
|Smaller businesses. Retail businesses||Larger businesses|
|Over the counter sale of goods||Purchase of goods with 15 day, 30 day, 45 day credit period|
Conclusion – cash transaction vs credit transaction:
Cash and credit transactions both have different impact on the balance sheet and cash flow of a business but both have the same impact on the profit and loss statement. It is however important to identify whether a transaction is cash or credit to determine the accounting treatment to be given. The key determinant is to understand the timing of actual payment/receipt in the transaction.