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:
- Transactions with Customers
- Transactions with Vendors
- Transactions with Employees
- Transactions with credit card companies
- Transactions with banks (loans, interest, repayment)
- 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 In – Cash 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.
Filed under: Financial Modeling and Cash Flow Projections | Tagged: Cash Flow Projections, Detailed cash planning, Transaction model | 6 Comments »