Article

Transaction Analysis: Learn the Basics

In this post, we look at the specific role of bank statement analysis during the onboarding and underwriting process and how advanced digital tools and technologies can help.

  • Brianna Valleskey
    Head of Marketing
Table of Contents
[ hide ][ show ]
  • Loading table of contents...

As technological advancements and digital capabilities improve the accuracy, speed, and accessibility of financial information, accounting has evolved and expanded, playing an even more critical role in business planning, management, and operations. 

When it comes to making sound business decisions, having a system in place to understand and interpret financial data is crucial. This is why successful companies are expanding their focus and placing more emphasis on analyzing data to generate relevant insights that can help increase transparency, inform decisions, and provide accurate real-time information to key stakeholders.

One of the most common and fundamental methods used for this purpose is called accounting transaction analysis. In this post, we explore how organizations can use this capability to better manage their financial data – and how they can use that data to improve efficiency, reduce risk, increase profitability, and fuel growth. 

What is Accounting Transaction Analysis?

Financial chart on a computer screen.

Accounting transaction analysis is the process of recording and evaluating the financial transactions that directly impact a company’s assets, liabilities, and equity. This helps provide a better understanding of an organization’s economic well-being, as well as assist the business in making accurate and informed decisions.

When conducted as an internal function, accurate and timely analysis of accounting transactions can help organizations:

  • Keep track of cashflow and project future income and expenses
  • Ensure that accounting standards and regulatory requirements are being met
  • Tailor products and services to better meet the needs of customers
  • Dictate pricing strategies and resource allocation
  • Identify areas of the business that are profitable or those that need improvement
  • Determine the value of the business should its owner decide to sell
  • Decrease losses by detecting erroneous or fraudulent activities 

By verifying that each financial event is accurately recorded, accounting transaction analysis ensures the reliability of a company’s financial statements, which are used to communicate its financial health to investors, analysts, regulators, and other partners. For this reason, valid information is crucial for transparency and trustworthiness.

The validity of financial data can impact important business relationships. For example, showing that a company is managing its finances responsibly and has a clear understanding of its financial health builds trust and instills confidence among shareholders. Demonstrating that transactions are processed smoothly and without errors can help foster customer satisfaction and loyalty. Finally, having accurate accounting records helps the company maintain compliance with government regulations and ensure contractual obligations are being met. 

Accounting transaction analysis can also help identify and evaluate the potential risks facing a company including fraud and non-compliance. It can also be a way for banks, financial institutions, insurers, rental agencies and other organizations to assess the creditworthiness of applicants and customers.

Understanding financial risk is essential for making well-informed and responsible business decisions. For more information, read our related post, Financial Risk Management: A Complete Overview.

The Accounting Equation: Foundation of Analysis

Person using computer software technology to help analyze credit.

The accounting equation serves as the foundation for accounting transaction analysis. A fundamental principle in accounting that represents the relationship between a company's assets, liabilities, and owner's equity, it is used to determine whether a transaction is accurate or not. The accounting equation states that a company’s assets must be equal to the sum of its liabilities and equity:

Assets = Liabilities + Equity

To maintain accurate records, a company’s accounting data should reflect a balance between what it owns and what it owes. This information is then reported on the balance sheet – a fundamental financial statement that provides a snapshot of the company's financial position at a specific point in time by showing how its assets, liabilities, and owner's equity are distributed.

It is important to make sure that the accounting equation remains balanced after each transaction. If it is not in balance, there is an input error somewhere that must be corrected. This verification process helps prevent mistakes and fraud, since any discrepancy in the equation would signal an error.

Transaction Analysis Process in 5 Simple Steps

Computer screen with accounting analysis code.

The transaction analysis process can be broken down into five clear steps: 

1. Identification

The first step of this process is identifying and isolating the financial events or transactions that impact the business. These could involve the sale of goods, purchase of supplies, receipt of cash, investments, loans, payment of a debt, or any other event involving the exchanging of funds between two or more entities.

2. Impact analysis

The next step is to assess how each transaction affects the accounting equation (Assets = Liabilities + Equity) to determine whether the equation remains balanced or if any adjustments are needed. This will have a direct impact on the company’s financial statements including the balance sheet, income statement, and cash flow statement. The goal is to understand the financial consequences of the transaction and ensure accurate recording. 

3. Account determination

This step involves identifying the specific accounts within the accounting system that should be impacted by each transaction. The standard double-entry accounting system necessitates that at least two accounts are involved in every transaction: one account will be debited (decreased) and another will be credited (increased).

Asset accounts represent the resources a business owns or controls and might include accounts such as cash, inventory, property, equipment, accounts receivable, investments, etc. Liability accounts represent the obligations a business owes to external parties and can include accounts payable, accrued taxes, outstanding loans, etc. 

For example, a transaction in which payment is received for services rendered would cause an increase in both assets (cash) and equity (revenue). Meanwhile, paying off a business loan would cause a decrease in assets (cash) and a decrease in liabilities (loan payable).

4. Increase & decreases analysis

Once the specific accounts have been identified, the next step is to determine how each part of the accounting equation (assets, liabilities, and owner's equity) is impacted by each specific transaction (i.e., whether each affected account should increase or decrease).

To ensure accurate recording, the principles of debits and credits must be applied. This is a core component of double-entry accounting, which is a common accounting system used by many organizations. 

According to this system, for every transaction, there must be at least two accounts affected: one that is debited and another that is credited. In addition, the total debits must always match the total credits, which ensures that the accounting equation remains in balance.

For example, debiting an account typically represents an increase in assets and expenses and a decrease in liabilities and revenues. Crediting an account usually represents an increase in liabilities and revenues and a decrease in assets and expenses. 

Adhering to the principle of debits and credits helps to ensure accurate recording of financial transactions and maintain the integrity of a company's financial statements.

5. Balance validation

Since the accounting equation must always balance, the last step in the transaction analysis involves verifying that the sum of assets is equal to the sum of liabilities and equity after accounting for the transaction.

By systematically analyzing transactions in this manner, businesses can ensure that their financial records accurately reflect the impact of each event, maintaining the integrity of financial records and clearly depicting the company's financial position.

Transaction Analysis Example

Financial paperwork, computer, calculator and piles of money on a table.

Let’s look at an example of a typical transaction where a company purchases $50,000 of equipment on credit. Prior to purchasing equipment, the company’s only assets were $100,000 in cash and net worth.

Step 1: Identification

In this example, there is only one monetary transaction impacting the business. The company has purchased equipment for $50,000 on credit, which means it is acquiring the equipment with a promise to pay for it later. 

Step 2: Impact analysis

In this scenario, assets should increase by $50,000. The company also incurs a new liability, because it now owes $50,000 to the vendor for the equipment.

Assets = Liabilities + Equity

$100,000 (cash) + $50,000 (equipment) = $50,000 (liabilities) + $100,000 (equity)

$150,000 = $150,000

The accounting equation remains balanced because the sum of the assets still equals the amount of the loan plus the owner's equity. 

Step 3: Account determination

There are two specific accounts impacted by this transaction: 

Assets: Equipment (there is no impact on cash, since this transaction is on credit)

Liabilities: Accounts Payable (the creditor must be repaid)

Equity: No direct impact in this case

Step 4: Increase & decrease analysis

For the purchased equipment to be properly recorded among the company’s assets, the equipment account should reflect an increase, or a debit. The obligation to make a future payment must also be reflected with a credit to accounts payable.

Equipment (asset): $50,000 debit

Accounts payable (liability): $50,000 credit

Step 5: Balance validation

For this transaction to be accurate, the accounting equation (Assets = Liabilities + Equity) should still hold. Since the business started with $100,000 in cash and $100,000 in owner’s equity, this transaction should cause the balance sheet to reflect $100,000 in cash, $50,000 in equipment, $50,000 of liability (specifically, accounts payable), and a total equity of $100,000.

Remember, this is a simplified example and does not reflect thorough instructions or steps to follow. In real-world scenarios, there could be additional considerations like taxes or fees. Always consult with an expert or refer to the tools and techniques below for specific accounting software when recording and analyzing transactions for accuracy. 

Transaction Analysis and Fraud Detection 

While most organizations use transaction analysis as an accounting tool, it also acts as an important safeguard against financial statement fraud.

By conducting regular and accurate financial statement analysis, companies can reduce the risk of this form of fraud by ensuring that every increase in sales, revenue, or asset book values with a corresponding growth/decline in inventory or cash flow. This helps accounting teams catch any errors, omissions, exaggerations or other forms of fraud within their financial statements.

For more information on this topic, please visit our related page, Financial Statement Fraud: Detecting, Cases & More.

Transactional Analysis: Tools & Techniques

Two computer monitors using data analysis technology.

With ongoing advancements in accounting technology, the tools and methods used for transaction analysis are constantly evolving. 

Some of the most common tools include:

  • Accounting software: Modern accounting software like QuickBooks, Xero, and FreshBooks can automatically record and categorize transactions. These programs can also generate reports, making analysis easier.
  • Fraud detection software: An AI-powered fraud detection tool like Inscribe helps you understand if a financial document is fraudulent and know what’s been altered within seconds. Taking the human manual effort out of fraud detection reduces vulnerability points internal or external parties could use to wreak havoc in your organization.
  • Spreadsheet software (e.g., Microsoft Excel, Google Sheets): Customized spreadsheet templates for recording and analyzing transactions can be used for calculations, data organization, and visualization.
  • Financial statements: Income statements, balance sheets, and cash flow statements provide essential financial data that can be analyzed to understand the impact of transactions on the business's financial health.
  • Ledgers and journals: Traditional accounting tools like ledgers and journals help track individual transactions and provide a chronological record that can be analyzed over time.
  • Transaction analysis worksheets: Custom-designed worksheets or business-specific templates can help systematically break down each transaction to apply the analysis process.
  • Financial advisors and consultants: Professional accountants, financial advisors, and consultants can offer expert insights into transaction analysis, especially for complex or specialized transactions.
  • Industry-specific software: Some industries have specialized software tailored to their unique accounting needs, such as software for managing inventory or tracking project costs.
  • Internal controls and audit trails: Having systems in place that provide internal controls and audit trails can help ensure accurate recording and analysis of transactions, enhancing accountability.

Final Thoughts on Transactional Analysis

The dynamic nature of the modern business environment, combined with technological advancements and evolving regulatory requirements, has increased the importance of transaction analysis. Not only is it a critical function for businesses to ensure financial transparency, compliance, and effective decision-making in an increasingly complex and interconnected global economy, but it is a powerful tool for risk management and fraud prevention.

Ready to take your transaction analysis capabilities to the next level? Talk to one of our experts to find out how Inscribe can help your organization combat financial statement fraud with automated document reviews.

Start your AI journey today

See how Inscribe can help you unlock superhuman performance with AI Risk Agents and Risk Models.