Transaction Models

Transaction Modeling

For some people, a transaction model is a financial model of a complicated transaction, for example a real estate deal or an acquisition.  Transaction in this sense really means “deal.”

However, the type of Transaction Models I’m going to write about in this article refer to transactions as accounting type transactions – e.g. a sale that generates an invoice;  or a payment to a vendor.

Your accountant will tell you that each transaction consists of a debit and a credit.  But don’t let that scare you away!  You don’t have to be an accountant to do transaction modeling.  Rather you have to roll your sleeves up, and pay attention to the details that affect cash.  What you do is forecast all the cash-affecting transactions you expect to occur over some planning horizon (usually 3 or 4 months), and then tabulate them in such a way that reveals your cash balance week by week (or day by day) within that planning horizon.

Here are the most common types of transactions that impact cash:

  1. Transactions with Customers
  2. Transactions with Vendors
  3. Transactions with Employees
  4. Transactions with credit card companies
  5. Transactions with banks (loans, interest, repayment)
  6. Transactions with governments (withholding taxes, sales taxes, property taxes, etc.)

Transaction modeling is used for doing detailed cash planning.   If you can determine all the transactions that will occur for your company for a specific time period  in the future, you can determine the net change in cash for that time period.  So, if you know what your cash balance is to start with (I hope you do!),  you can estimate for each time period in the future how much cash you’ll have on hand.

Because for any time period:

Ending Cash = Beginning Cash + Net Change in Cash

Net Change in Cash = Cash InCash Out

Cash In = The sum of all transactions bringing in cash

Cash Out = The sum of all transactions sending out cash

Here’s how each of these looks:

Transactions with customers

Your Company  ==> Products or Services ==> Customers

Customers ==> Cash  [Delay based on terms] ==> Your company

Customers ==> Credit Cards [Delay based on processing] ==> Cash ==> Your Company

Transactions with Vendors

Vendors ==> Products and Services ==> Your Company

Your Company ==> Cash [Delay based on terms granted] ==> Vendors

Transactions with Employees

Employees ==> Work ==> Your Company

Your Company ==> Cash [Delay based on company policy] ==> Employees

Transactions with Credit Card Companies

Your company ==> Uses credit card for products or services ==> Increases balance owed to Credit Card company

Your company ==> Cash (for interest, fees, and principal) ==> Decreases balance owed to Credit Card Company

Transactions with Banks

Bank ==> Agrees to  loan Cash ==> Your Company

Your company ==> Cash (for principal and interest) ==> Bank

Transactions with Governments

Your Company ==> Cash  (for sales tax, withholding tax, income tax) ==> Government

Back to Transaction Modeling

So the idea is to forecast all the transactions for some period of time, and see how the cash shakes out week  by week.  Many of the transactions are easy to forecast – such as the rent payment, payroll, etc.  These are under your cotrol.   Others are not so easy to forecast:  what will sales be next week?  When will company ABC pay their invoice?  Will the bank agree to my loan request?

In upcoming articles we’ll examine different approaches to developing a Transaction Model and using it to do detailed cash projections for your business.  The same approach can be used for your personal finances as well.

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8 Responses

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