Transaction Cost Analysis | 5 mins read

Understanding Transaction Cost Analysis

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Lauren Christiansen

By Lauren Christiansen

What Are Transaction Costs?

As the world faces economic uncertainty and fluctuating market conditions, business owners have to make difficult choices. Between labor costs and operating expenses, small business profit margins are often razor-thin. Identifying areas of waste and minimizing inefficiencies can help boost sales and streamline operations. But first, owners need to document all of their expenses to see the root cause of waste. One best practice is to record all transaction costs and then perform a cost analysis.

So, what exactly is a transaction cost? Transaction costs include any expenses incurred when a business purchases or sells a product or service. Yes; it does indeed cost money to sell an item to customers. All of the labor utilized to produce this product or service is factored into transaction costs. As everyone knows, labor expenses are expensive and prone to waste.

On Wall Street, a transaction cost would include any commission paid to a stockholder who handles and completes a share deal. In the business world, a transaction expense may be a fee charged to a customer when running a credit card. Another example may include the expense of a salesman to travel and complete a deal with a client. Companies charge transaction costs because they need to make up for those labor expenses, time, and credit card processing fees.

A transaction cost can also be any exchange performed at a brick and mortar. For example, when a woman purchases an item at a retailer, it costs the retailer money to process that exchange. The cashier's wages, POS system expenses, and time are all part of transaction costs. This is why profit margins can be so small, and why performing a transaction cost analysis is so critical.

What is Transaction Cost Analysis?

So now that the definition of transaction cost is clear, it's time to discuss the importance of a cost analysis. A transaction cost analysis TCA enables owners to assess all of the incurred costs of performing a transaction. Various benchmarks should be utilized to ensure each cost is covered by enough profit to make it worthwhile. Many companies utilize interactive tables and automated software tools to perform this analysis. This makes it easier to understand the results upon its presentation.

The analyst will compare the price of each exchange to an applicable benchmark to indicate how cost-effective it is. If the number is positive, that means the exchange was a net benefit. If it was negative, then there are areas of waste within the exchange that make it not worthwhile. Read ahead to know the analysis TCA benchmarks that most companies utilize.

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1. Transaction Cost Analysis Benchmark - Marketability

This benchmark in a transaction cost analysis determines whether an exchange was marketable, which implies an item was sold at a price higher or equal to its purchased price. For example, if a restaurant's sales outweigh the cost of labor, then the menu items are marketable. If the cost to employ a cashier, server, and a POS system are eating into profit margins, then the diner is in trouble. It would need to cut labor expenses or increase prices, though customers are usually not fond of the latter. This is particularly true if the item is not more valuable than it was before.

2. Transaction Cost Analysis Benchmark TC

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Each exchange has expenses associated with it. For example, a salesperson must be paid a commission upon selling an item to a customer. This means the employer must pay out a certain amount of that sale, rather than taking all the profit. This benchmark compares exchanges to industry-related benchmarks.

In this previous example, the industry-related transaction cost benchmark could be how much commission other employers are paying their sales team for a similar exchange. This enables a company to analyze the quality and effectiveness of the transaction, and pinpoint any waste.

3. Transaction Cost Analysis Benchmark Basis Points

Basis points typically refer to any changes in interest rates or the amount a lender charges to sell or maintain an item. The amount is indicated as a percentage. Basis points may not apply to each industry. It does apply to banking, accounting, and other financial sectors. Interest rates change when demand and supply of an asset fluctuate, or when there is a high risk to lend/maintain an asset.

In a cost analysis TCA, lower interest rates are more expensive for financial industries. However, when costs are lower there tends to be more interest in the asset from the consumer. Depending on the industry and market conditions, an organization may see the high-interest rate as positive or negative. This will impact the cost analysis and determine whether an exchange is worthwhile.

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4. Transaction Cost Analysis Benchmark Other

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Numerous other variables impact the quality of an exchange. Companies may also utilize the following benchmarks-

  • Price Improvement - When orders are exchanged at better prices than the typically quoted price in the market.
  • Arrival Price - Utilized to mitigate the trade-off between the impact of the market and any associated price risk (decline of an investment due to multiple factors).
  • Volume - The amount of an item that goes through different stakeholders in the supply chain over a timeframe.
  • Trade Date - The month, year, and date that a transaction occurred. This can impact a sale's quality and identify whether it's the best execution (or not).
  • Trade Price - The cost of items sold to companies by the vendors who manufactured them. If it is too expensive, the transaction cost will be higher because the company needs to compensate for it.

Key Takeaways of Transaction Cost and Analysis

In conclusion, here is what to know about an analysis TCA -

  • Transaction costs are the expenses incurred when a company buys or sells an item. These include operating and labor expenses. Companies need to monitor and manage these expenses to maximize profitability.
  • A transaction cost analysis utilizes a set of benchmarks to assess the effectiveness and quality of one or more transactions.
  • Various benchmarks in a cost analysis include marketability, transaction cost, and basis points.
  • Other companies may use benchmarks such as price improvement, arrival price, volume, trade date, and trade price.

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