The Three Types of Sales Transactions
The effect that making a sale has on a business’s financial condition depends on the type of sales transaction that's made — that is, when the cash is collected from the sale When a business sells a product or service, cash may be collected at the time of the sale (called a cash sale), after the sale (on credit), or before the sale (an advance payment).
One of the most quoted sayings in business is, “Nothing happens until you sell it.” Well, there’s no doubt that a business has to make sales that generate enough sales revenue to overcome its expenses and leave a residual of profit.
Regarding cash collection, sales come in three flavors:
Cash sales: Cash is collected when the business makes the sale and delivers the product and/or service to the customer.
Credit sales: Cash isn’t collected until sometime after the sale is made; the customer is given a period of time before it has to pay the business.
Advance payment sales: The customer pays the business before the sale is consummated, that is, before the business delivers the product and/or service to the customer.
No doubt you’re familiar with cash and credit sales. For the third type of sale, at the time of receiving an advance payment, the business does not record a sale; instead, it records a liability that stays on the books until the product or service is actually delivered to the customer. This specific liability is one of the business’s operating liabilities.
For example, paying for an annual subscription to a newspaper is considered an advance payment for delivery of the newspaper every day for the coming 12 months. Similarly, if you want to purchase season tickets for your favorite NFL football team, you would need to make an advance payment, before the season starts. A gift certificate is another example of an advance payment sale. The liability of the advance payment sale is extinguished as papers are delivered, games are played, and gift certificates are redeemed.
If a business recorded $3,200,000 in sales revenue for the year just ended, can you tell how its balance sheet changed as the result of that sales revenue? No, you can’t — unless the business makes only cash sales. If the business makes credit sales or collects advance payments from customers for future sales, then the changes in its balance sheet caused by sales are a little more involved.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
