Debit card transactions are generally considered cash transactions because the funds are immediately deducted from the cardholder's checking account upon purchase, similar to cash payments.
The purchase volume on debit cards in the United States was $4.9 trillion in 2023, underscoring how often debit cards are used and the importance of correctly classifying the potentially huge volume of transactions.
This article will cover the most important factors to consider when classifying debit card transactions. These valuable insights will help business owners and accounts receivable professionals make informed decisions regarding the proper classification of these common transactions.
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Key takeaways:
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Impact of debit card transactions on a business's cash flow
Debit card transactions have a significant impact on a business's cash flow. When a customer makes a purchase using a debit card, the funds are immediately deducted from the business's bank account.
This immediate deduction affects the business's liquidity, which is the ability to meet short-term financial obligations.
If a business does not have sufficient cash on hand, it may need to borrow money or use other sources of financing to cover the debit card transactions. This can lead to increased interest expenses and other financial costs.
Debit card transactions vs. accounts receivable: Key differences
Debit card transactions:
- Immediate deduction of funds from the cardholder's checking account upon purchase.
- Considered cash transactions in accounting.
- Funds are not owed to the business and are immediately available.
Accounts receivable:
- Represent money owed to the business for goods or services sold on credit.
- Funds are not immediately available and must be collected from customers.
- Recorded as an asset on the balance sheet.
- Subject to credit risk and bad debt expense.
Accounts receivable (AR) is an asset account that represents the amount of money owed to a business by its customers for goods or services sold on credit.
When a customer purchases goods or services on credit, the business records a sale and recognizes revenue. This transaction creates an account receivable, which represents the amount of money that the customer owes the business. The amount of the sale is recorded as a debit to accounts receivable and a credit to sales revenue.
The customer's obligation to pay the business is a legal liability. The business has the right to collect the amount owed from the customer, and the customer is obligated to pay the amount owed. The accounts receivable balance represents the total amount of money that customers owe the business.
By comparison, a debit card transaction is essentially an electronic cash payment, which is immediately deducted from the customer's account balance and paid to the business.
The importance of proper accounts receivable management
The accounts receivable balance is a valuable asset for the business. It represents money that the business has earned but has not yet collected. The business can use this asset to finance its operations, invest in new opportunities, or pay its creditors.
However, receivables can also be a business risk. If a customer does not pay the amount owed, the business may have to write off the debt as a bad debt. This can cause a loss of revenue and a decrease in the accounts receivable balance.
To manage this risk, businesses typically have a credit policy that establishes the terms of credit for customers. This policy includes the credit limit, the payment terms, and the interest rate charged on overdue accounts. Businesses also typically monitor their Accounts Receivable aging report to identify customers who are past due on their payments.
Practical examples of accounting for debit card transactions
The following examples illustrate how debit card transactions are recorded in the accounting records of a business. By understanding how these transactions are recorded, companies can ensure their financial statements are accurate and complete.
Scenario 1: Customer purchases a product using a debit card
When a customer purchases a product using a debit card, the business will receive the payment immediately. An example journal entry to record this transaction is:
Debit: Cash $100
Credit: Sales revenue $100
This entry increases the cash balance of the business by $100 and increases the sales revenue by $100. The debit to Cash represents the increase in cash received from the customer, and the credit to Sales revenue represents the income earned from the sale of the product.
Scenario 2: Business receives a debit card payment for a service rendered
When a business receives a debit card payment for a service rendered, an example journal entry to record this transaction is:
Debit: Accounts receivable $500
Credit: Service revenue $500
This entry increases the accounts receivable balance by $500 and increases the service revenue by $500. The debit to Accounts receivable represents the amount owed to the business by the customer, and the credit to Service revenue represents the income earned from the provision of the service.
Scenario 3: Business refunds a customer's debit card purchase
When a business refunds a customer's debit card purchase, the following journal entry could be made:
Debit: Sales returns and allowances $75
Credit: Cash $75
This journal entry reduces the sales returns and allowances balance by $75 and reduces the cash balance by $75. The debit to Sales returns and allowances represents the decrease in sales revenue due to the refund, and the credit to Cash represents the decrease in cash paid to the customer.
Debit card transactions are cash not accounts receivable
Debit card transactions are classified as cash in accounting because the funds are immediately deducted from the cardholder's checking account upon purchase. This treatment aligns with the fundamental principle of cash basis accounting, which recognizes revenue when cash is received or an asset is acquired. By classifying debit card transactions as cash, businesses can accurately reflect their financial position and track their cash flow effectively.
Chaser offers a comprehensive solution for businesses to manage both their cash income through the Payment Portals and Chaser Pay, and their receivables with an end-to-end accounts receivable automation solution.
Chaser Pay’s integrated platform allows businesses to accept debit card payments, process invoices, and track their receivables in one centralized location.
By leveraging Chaser's solution, businesses can streamline their cash management processes, improve efficiency, and gain valuable insights into their financial operations.
To learn more about how Chaser can help your business, speak to an expert for personalized guidance and recommendations.
