Business transaction analysis is the correct tool in accounting and financial reporting. Every business transaction conducted on a sale side or expense level impacts the financial well-being of a business; hence, all must be done correctly recorded. This article will guide you through the steps for correct analysis of business transactions.
Step1: Understand the Nature of the Transaction
Understanding what the transaction is forms the first step of analysis of any business transaction. Business transactions can generally be classified in one of the following categories:
Revenue: Income accrued because of the operations of the business-for instance, sales of goods or services.
Expenses: Costs incurred to acquire income – examples include rent, utilities, and salary.
Assets: Resources or products owned by the business- examples include cash, equipment, and inventory.
Liabilities: obligation owed to other parties, such as accounts payable or loans.
Equity: owner’s contribution to the business, including retained earnings and capital contributions.
Knowing what kind of transaction you need, you determine which accounts it will affect and whether it will increase or decrease the balance of an account.
Step2: Identify who to bill
Once you determine the transaction type, you’ll want to identify the accounts that this applies to. Generally, a transaction will impact two or more accounts with a double-entry accounting system. Here’s an example:
Cash Sales: This transaction impacts both the Cash account (asset) and the Sales Revenue account (revenue).
Credit purchase of inventory: an entity purchasing merchandise has increased an asset-Inventory-and added to a liability for the purchases, in this case, Accounts Payable.
Payment of Expenses: This typically makes use of the Cash account (asset) and an Expense account (expense).
You’ve identified what accounts are being affected, but you’ve started laying the groundwork for proper recording.
Step3: Use Double-Entry System
The double-entry accounting system ensures that each transaction has been addressed in at least two accounts: one account is debited while the other is credited. With this, the accounting equation, reading Assets = Liabilities + Equity, gets balanced. This is explained further below:
Debit: Credit on the left side of an account, leading to an increase in both assets and expenses and decrease in liabilities and equity.
Credit: A debit entry that is posted on the right side of the account increases liabilities and equity but decreases assets and revenues. For example,
Cash Purchase of Equipment: Debit the asset account Equipment and credit the asset account Cash.
Sales on Credit: Debit the asset account Accounts Receivable and credit the revenue account Sales Revenue.
Correct application of debits and credits ensures that accounts are always balanced by every transaction.
Step4: Analyse the following transaction’s financial impact
Then, evaluate how it will affect the financial health of the company. Some of the questions to answer are:
Does this transaction increase or reduce cash flow?
Does it impact profitability? Sales, for example, would increase revenue. Some of the expenses, on the other hand, would reduce a profit.
Will it increase or decrease the company’s debt or equity?
For instance, a cash sale boosts both cash flow and profitability, whereas debt increases cash temporarily and also raises liabilities. Identifying the financial impact opens up how every transaction build on or reduces the total financial picture.
Step5: Record the transaction appropriately
The good thing is that proper documentation ensures that every transaction will be traceable, verifiable, and can even be included in invoices, receipts, contracts, or bank statements. These represent a paper trail for the auditors to work with in proving the accuracy of financial statements.
Step 6: Record the Transaction in the Ledger
With the analysis and documentation of the transaction complete, it is now a matter of posting the transaction in the ledger. The ledger accounts make up a detailed record of all financial transactions in an organized manner, by account. Every single transaction should be recorded with the date, debit and credit entries, and a brief description. The ledger allows tracking of the balance in each of the accounts, and that balances are the basis of accurate financial reporting.
Step7: Verify and Crosscheck
Finally, verify the correctness of the transactions. Routine checks of transactions reduce even the small mistake to build up within the books and allow reflection of the true financial position of the business. In general, inconsistencies and discrepancies become easier to identify to make corrections on time.
Business transaction analysis is important to help business owners maintain the authenticity of financial records while appropriately comprehending how well the company’s finances are being managed. It is achieved through the understanding of the type of transaction, identification of which accounts are being affected, the implementation of double entry principles, and also clear documentation of each transaction in consideration for complete accuracy in financial reporting. Reviews on regular basis enhance such accuracy so that business owners and managers may make financial decisions effectively.