The third article of our series on sales and purchases.
Study Tips: Sales and purchases series
- 1 – Buying and selling
- 2 – Documentation behind buying and selling
- 3 – Difference between cash and credit transactions
- 4 – Sales and purchases in double entry bookkeeping
- 5 – Cash and credit transactions in double entry bookkeeping
In the third part of our sales and purchases series, we’ll look at the difference between cash and credit transactions.
Having looked at the business basics of sales and purchases in part one, and then paperwork in part two, we’re now only one step away from applying that knowledge and understanding to a double entry bookkeeping system.
The last element we need to consider is how invoices get settled once they’ve been generated and received by a customer.
Sales and purchases scenario
If you remember from previous articles in this series, Emily sold Adam some stationery.
Emily is the supplier and has generated the invoice for this transaction. Adam is the customer and has received the invoice from Emily and checked it against his purchase order and the goods he received.
Assuming that everything is okay with the transaction and paperwork, the only thing left to do is for Adam to pay the invoice.
Let’s assume that Adam actually went to Emily’s Stationery Company and ordered the goods in person at the counter. Emily got what he wanted out of her stockroom and generated the invoice there and then. Adam checked it was what he wanted, and then paid Emily on his business debit card.
This would be an example of a cash transaction. There are a few points to note about cash transactions:
- The timing of the payment is important – money changes hands at the point of sale.
- The method of payment is not important – cash transactions can be made with actual notes and coins, cheques, debit or credit cards. They can also be made using bank transfers.
- There is no pre-existing agreement between the supplier and customer.
Let’s now consider what would happen if there was a pre-existing agreement between Emily and Adam.
That would mean that Adam had applied to Emily for credit and asked her to set him up with a supplier’s account so that he could delay paying for his goods.
Emily would have checked to see if Adam was credit worthy and then put a formal agreement in place, stating that Adam can buy and have stationery without paying for it at the point of sale, on the understanding that he will pay for it within a certain period of time.
The invoice in part two shows payment terms of ’14 days after invoice date’.
This tells us Adam and Emily have a credit agreement, therefore, let’s say that Adam sent Emily his order by email and that she sent the goods along with a delivery note by courier. She then followed up by emailing the invoice. Adam carried out his checks and then set up a bank transfer to pay the invoice on 11 May, as the invoice is dated 27 April.
This is now an example of a credit transaction. There are a few points to note about credit transactions:
- The timing of the payment is important – money changes hands after an agreed period of time.
- The method of payment is not important – credit transactions can be made with actual notes and coins, cheques, debit or credit cards. They can also be made using bank transfers.
- There is a pre-existing agreement between the supplier and customer.
The end result of a sale/purchase is that the customer has to pay for the goods and the supplier receives the money. The actual method of payment has no bearing on whether a sale/purchase is a cash or credit transaction. The crucial distinction is the timing of the payment.
Credit transactions are made possible by the agreements suppliers put in place to extend credit to their customers, allowing them to delay paying for goods or services.
The next two articles on sales and purchases will look at sales and then purchases in double entry bookkeeping systems.
The next article in the series will answer the question, “what’s the difference between sales, sales ledger and sales ledger control account?” This is a question I hear all too often and implies a lack of understanding about the difference between cash and credit transactions.
Now we have that though, we can compare and contrast the double entry needed for each and see, through looking at the T accounts, that the only difference is the timing.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.