Financial transaction

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Financial transaction involving money and agricultural goods at a farmers' market Transaction at a Farmers' Market.JPG
Financial transaction involving money and agricultural goods at a farmers' market

A financial transaction is an agreement, or communication, between a buyer and seller to exchange goods, services, or assets for payment. Any transaction involves a change in the status of the finances of two or more businesses or individuals. [1] A financial transaction always involves one or more financial asset, most commonly money or another valuable item such as gold or silver. [2]

Contents

There are many types of financial transactions. The most common type, purchases, occur when a good, service, or other commodity is sold to a consumer in exchange for money. Most purchases are made with cash payments, including physical currency, debit cards, or cheques. [3] The other main form of payment is credit, which gives immediate access to funds in exchange for repayment at a later date. [4]

History

Silver coin of the Maurya Empire, from the 3rd century BC MauryanCoin.JPG
Silver coin of the Maurya Empire, from the 3rd century BC

There is no evidence to support the theory that ancient civilizations worked on systems of barter. Instead, most historians believe that ancient cultures worked on principles of gift economy and debt. [5] In a gift economy, valuables are given without any formal declaration of repayment, often thought to be a form of reciprocal altruism. [6] Official systems of credit and debt were first created around 1800 BCE by the Babylonians, who established the first formal interest rate limits with the Code of Hammurabi. [7]

Many cultures around the world began using commodity money —objects whose value comes from their intrinsic value. [8] These often included gold or silver coins, along with non-metal objects such as cowrie shells, beaver pelts, and dried corn. [9] [10] Between 1000 BCE and the first millennium CE, coinage became increasingly common throughout Europe and Asia. [11] In England, banknotes were introduced starting in the 17th century. Each note promised to pay the bearer the value in gold upon demand—this is called a gold standard. [12] In the 20th century, many countries gradually phased out the gold standard in favour of fiat money —money that is not backed by any commodity. [13]

Since the start of the 21st century, online banking has become much more widespread. By 2001, tens of millions of people were doing their banking on the internet. [14] By 2012, between 46 and 82 percent of all transactions were done electronically. [15] Digital currencies, currency that is stored on electronic systems, have gained popularity. Bitcoin, invented in 2009, reached a cap of over US$1 trillion in 2021. [16] One of the downsides of cryptocurrencies is that since they are not tethered to any tangible assets, their price can fluctuate wildly, sometimes by 20% or more in a single day. [17]

Types of transactions

Purchases can be made through the use of physical currency, such as cash. Currency in USD 2.jpg
Purchases can be made through the use of physical currency, such as cash.

Cash transactions

A cash transaction is any transaction where money is exchanged for a good, service, or other commodity. Cash transactions can refer to items bought with physical money, such as coins or cash, or with a debit card. These differ from credit transactions because the money is immediately taken from the buyer and given to the seller. [18] [19]

Credit transactions

Transactions that use credit involve a deferred payment for the goods or services rendered. When something is bought using credit, it gives the seller an asset (the payment at a later date) and gives the buyer a liability (the amount that must be paid at a later date). [20] Credit cards are an example of when credit is used, where the card issuer (usually a bank) gives the customer a line of credit with which they can make purchases. The liabilities the customer accrues with the card are usually paid off at a set date, and any unpaid liabilities create interest for the issuer. [21]

Loans and mortgages are examples of credit. The lender agrees to give out a lump sum (the "principal") to the borrower, who pays back the loaned amount over a set period of time (called a "term"). The lender usually charges an additional percentage on top of the initial amount borrowed, called the "interest rate". [22] Mortgages are similar to loans, but are usually for a larger amount of money and over a longer term, often for buying real estate. [23] Mortgages are almost always secured by collateral, most commonly the real estate they are being used to purchase. If the borrower fails to make the necessary payments on the mortgage, the lender has the right to claim and sell the property in a process known as foreclosure. [24]

Internal and external transactions

External transactions are any business transactions that involve more than one party. For example, a company buying inventory from a supplier would be considered external. All cash and credit transactions are external, since they affect the finances of more than one person or group. [25] On the other hand, internal transactions only affect one business. Shifting goods between different departments in a business is an internal transaction, since it does not change the overall finances of the company. [26]

See also

Related Research Articles

In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the underlying. Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets.

<span class="mw-page-title-main">Money laundering</span> Process of concealing the origin of money

Money laundering is the process of illegally concealing the origin of money obtained from illicit activities such as drug trafficking, underground sex work, terrorism, corruption, embezzlement, and gambling, and converting the funds into a seemingly legitimate source, usually through a front organization.

<span class="mw-page-title-main">Financial market</span> Generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

<span class="mw-page-title-main">Debt</span> Obligation to pay borrowed money

Debt is an obligation that requires one party, the debtor, to pay money borrowed or otherwise withheld from another party, the creditor. Debt may be owed by sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of principal and interest. Loans, bonds, notes, and mortgages are all types of debt. In financial accounting, debt is a type of financial transaction, as distinct from equity.

The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.

An escrow is a contractual arrangement in which a third party receives and disburses money or property for the primary transacting parties, with the disbursement dependent on conditions agreed to by the transacting parties. Examples include an account established by a broker for holding funds on behalf of the broker's principal or some other person until the consummation or termination of a transaction; or, a trust account held in the borrower's name to pay obligations such as property taxes and insurance premiums. The word derives from the Old French word escroue, meaning a scrap of paper or a scroll of parchment; this indicated the deed that a third party held until a transaction was completed.

Credit risk is the possibility of losing a lender holds due to a risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk will be associated with higher borrowing costs. Because of this, measures of borrowing costs such as yield spreads can be used to infer credit risk levels based on assessments by market participants.

<span class="mw-page-title-main">Transaction account</span> Bank holding that clients can access on demand

A transaction account, also called a checking account, chequing account, current account, demand deposit account, or share account at credit unions, is a deposit account or bank account held at a bank or other financial institution. It is available to the account owner "on demand" and is available for frequent and immediate access by the account owner or to others as the account owner may direct. Access may be in a variety of ways, such as cash withdrawals, use of debit cards, cheques and electronic transfer. In economic terms, the funds held in a transaction account are regarded as liquid funds. In accounting terms, they are considered as cash.

<span class="mw-page-title-main">Digital currency</span> Currency stored on electronic systems

Digital currency is any currency, money, or money-like asset that is primarily managed, stored or exchanged on digital computer systems, especially over the internet. Types of digital currencies include cryptocurrency, virtual currency and central bank digital currency. Digital currency may be recorded on a distributed database on the internet, a centralized electronic computer database owned by a company or bank, within digital files or even on a stored-value card.

A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS). Like other private label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived from ratings on those bonds or assets.

An asset-backed security (ABS) is a security whose income payments, and hence value, are derived from and collateralized by a specified pool of underlying assets.

<span class="mw-page-title-main">Murabaha</span> Type of Islamic finance

Murabaḥah, murabaḥa, or murâbaḥah was originally a term of fiqh for a sales contract where the buyer and seller agree on the markup (profit) or "cost-plus" price for the item(s) being sold. In recent decades it has become a term for a very common form of Islamic financing, where the price is marked up in exchange for allowing the buyer to pay over time—for example with monthly payments. Murabaha financing is similar to a rent-to-own arrangement in the non-Muslim world, with the intermediary retaining ownership of the item being sold until the loan is paid in full. There are also Islamic investment funds and sukuk that use murabahah contracts.

In the United States, a mortgage note is a promissory note secured by a specified mortgage loan.

A proof of funds (POF) is a document such as a bank statement proving that a person or a company has the financial ability to perform a transaction or meet a potential future liability. The POF can be issued by a bank, a financial institution or a trade finance provider.

Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).

<span class="mw-page-title-main">Cryptocurrency</span> Digital currency not reliant on a central authority

A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. It has, in a financial point of view, grown to be its own asset class. However, on the contrary to other asset classes like equities or commodities, sectors have not been officially defined as of yet though abstract version of them exist.

SoFi Technologies, Inc. is an American online bank and fintech company founded in 2011. It offers various loans, credit cards, stock investing and banking products. It also serves financial institutions through its technology platform. As of 2024, SoFi reports 8.8 million customers and 158 million platform accounts.

Venmo is an American mobile payment service founded in 2009 and owned by PayPal since 2013. Venmo is aimed at users who wish to split their bills. Account holders can transfer funds to others via a mobile phone app; both the sender and receiver must live in the United States. Venmo also operates as a small social network, as users can observe other users' public transactions with posts and emoticons. In 2021, the company handled $230 billion in transactions and generated $850 million in revenue. Users can view transactions on the Venmo website but cannot complete transactions on the website.

<span class="mw-page-title-main">Automated clearing house</span> Type of electronic network for financial transactions

An automated clearing house (ACH) is a computer-based electronic network for processing transactions, usually domestic low value payments, between participating financial institutions. It may support both credit transfers and direct debits. The ACH system is designed to process batches of payments containing numerous transactions, and it charges fees low enough to encourage its use for low-value payments.

Decentralized finance offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks by using smart contracts on a blockchain, mainly Ethereum. DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts. DeFi uses a layered architecture and highly composable building blocks. Some applications promote high-interest rates but are subject to high risk. Coding errors and hacks have been common in DeFi.

References

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  2. ↑ "What is a Financial Transaction? (with picture)". Smart Capital Mind. Archived from the original on 9 November 2022. Retrieved 8 February 2022.
  3. ↑ "Accounting Transactions". Corporate Finance Institute. Archived from the original on 28 September 2022. Retrieved 8 February 2022.
  4. ↑ "What is credit? | CIBC". www.cibc.com. Archived from the original on 9 November 2022. Retrieved 8 February 2022.
  5. ↑ Smith, Yves (26 August 2011). "What is Debt? – An Interview with Economic Anthropologist David Graeber". naked capitalism. Archived from the original on 22 January 2023. Retrieved 8 February 2022.
  6. ↑ Cheal, David J (1988). "1". The Gift Economy. New York: Routledge. pp. 1–19. ISBN   0-415-00641-4 . Retrieved 18 June 2009.
  7. ↑ Desjardins, Jeff. "INFOGRAPHIC: The 5,000-year history of consumer credit". Business Insider. Archived from the original on 11 November 2022. Retrieved 8 February 2022.
  8. ↑ "What Is Money?". Investopedia. Archived from the original on 30 January 2023. Retrieved 8 February 2022.
  9. ↑ Jan Hogendorn; Marion Johnson (1986). The Shell Money of the Slave Trade. Cambridge: Cambridge University Press. ISBN   9780521541107 . Retrieved 29 April 2015.
  10. ↑ "Commodity Money: Introduction". coins.nd.edu. Archived from the original on 9 November 2022. Retrieved 9 February 2022.
  11. ↑ Kusimba, Chapurukha (20 June 2017). "When – and why – did people first start using money?". The Conversation. Archived from the original on 16 February 2023. Retrieved 9 February 2022.
  12. ↑ "Banknotes: a short history". the Guardian. 10 September 2013. Archived from the original on 28 January 2023. Retrieved 9 February 2022.
  13. ↑ Dowd, Kevin (2001). "THE EMERGENCE OF FIAT MONEY: A RECONSIDERATION" (PDF). Archived (PDF) from the original on 17 August 2022. Retrieved 8 February 2022.
  14. ↑ "The History of E-Banking". Bizfluent. Archived from the original on 9 November 2022. Retrieved 9 February 2022.
  15. ↑ Eveleth, Rose. "The truth about the death of cash". www.bbc.com. Archived from the original on 9 November 2022. Retrieved 9 February 2022.
  16. ↑ "Cryptocurrencies, Digital Dollars, and the Future of Money". Council on Foreign Relations. Archived from the original on 9 November 2022. Retrieved 9 February 2022.
  17. ↑ Boukhalfa, Sofiane (16 November 2019). "What are the disadvantages of cryptocurrencies? - PreScouter - Custom Intelligence from a Global Network of Experts". PreScouter. Archived from the original on 9 December 2022. Retrieved 9 February 2022.
  18. ↑ "Cash Transaction - Definition, What is Cash Transaction, and How Cash Transaction works?". cleartax.in. Archived from the original on 9 November 2022. Retrieved 15 February 2022.
  19. ↑ "Cash Transaction". Investopedia. Archived from the original on 9 November 2022. Retrieved 16 February 2022.
  20. ↑ "Difference between cash transaction and credit transaction". Termscompared. 28 July 2019. Archived from the original on 9 November 2022. Retrieved 16 February 2022.
  21. ↑ White, Alexandria (8 June 2020). "What is a credit card?". CNBC. Archived from the original on 17 November 2022. Retrieved 16 February 2022.
  22. ↑ "Learn Exactly How Loans Work Before You Consider Borrowing Money". The Balance. Archived from the original on 12 August 2022. Retrieved 16 February 2022.
  23. ↑ Thakur, Madhuri (14 February 2019). "Loan vs Mortgage | Top 7 Best Differences (With Infographics)". Archived from the original on 9 November 2022. Retrieved 15 February 2022.
  24. ↑ "What is a difference between loan and mortgage?". www.scotiabank.com. Retrieved 16 February 2022.
  25. ↑ "Business Transaction - Types, Definition, Explanation and Examples". Accounting For Management. 25 March 2017. Archived from the original on 12 December 2022. Retrieved 16 February 2022.
  26. ↑ "Difference between internal transaction and external transaction". Termscompared. 30 July 2019. Archived from the original on 9 December 2022. Retrieved 16 February 2022.
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