Transaction categorization can be referred to as the process of assigning a specific category or tags to a financial transaction, such as a purchase, credit, or deposit, for tracking expenses, budgeting, and generating financial reports. In this blog, we will look into it in a detailed manner.
Benefits of Transaction Categorisation
Transaction Categorisation works well to give you insights into the financial aspects of your expenses. Some categories for transactions include groceries, dining out, travel, entertainment, bills, and personal care. By categorizing transactions, individuals and businesses can better understand where their money is going and can make more informed financial decisions accordingly. Here are some of the benefits:
- Easy access to financial information to track spending.
- Evaluation of Your Financial Habits and what are those areas where you spend more.
- Helps track recurring expenses and new expense categories.
- Gives more control over your spending.
Different Ways of Transaction Categorization
- Manual Categorization– In this way of transaction categorization, transactions are manually categorized. The user has the freedom to choose which categories they prefer to use and create subcategories based on requirements. However, this procedure is time-consuming and can cause errors.
- Rule-Based Categorization– In this procedure, the Categorization takes place based on predefined rules. For example, all transactions from a specific vendor or in a specific price range can be automatically categorized into a certain category.
- Machine Learning-Based Categorization– In this procedure, algorithms are learned via machines and are therefore used to categorize transactions automatically. The knowledge of algorithms from the historical transaction data is used to categorize new transactions. This procedure seems to be more accurate and time-saving than rule-based Categorization. The apps and software are quite better in it, and they use Machine Learning techniques for transaction categorization.
- Hybrid Categorization– Hybrid Categorization can be termed as a combination of both Rule-Based Categorization and Machine Learning Based Categorization. Over here, transactions are first categorized by predefined rules and then by machine learning algorithms to refine and improve the efficiency of Categorization.
- Cluster Analysis– In this type of Categorization, all the transactions form together into a cluster on the basis of their similarity. This procedure helps to identify the frauds easily while the Categorization goes on.
- Custom Categorization– This kind of Categorization involves making custom categories that are specific to a user’s needs or preferences, such as “work-related expenses” or “hobby expenses.”
Uses of Transaction Categorization in Business:
Transaction categorization can be defined as an important aspect of financial management in business.
- Expense tracking: Categorizing transactions by type allows businesses to track their expenses more effectively. Here, one can identify areas where expenses are too high or where cost savings can be achieved.
- Budgeting: Businesses can create a budget that aligns with their financial goals by categorizing transactions. This allows them to plan for future expenses and make better financial decisions.
- Tax reporting: Categorizing transactions by tax category makes it easier to prepare tax returns and ensures that all deductible expenses are accounted for.
- Financial reporting: Categorizing transactions is also useful for financial reporting. This provides a clear picture of the company’s financial situation and helps with the financial analysis.
- Fraud prevention: Categorizing transactions can help detect fraudulent activity. By monitoring transactions in each category, businesses can identify unusual patterns or discrepancies that may indicate fraud.
In summary, transaction categorization is a critical component of financial management in business and is valuable for individuals. It provides us with valuable insights into a financial situation and helps us make informed decisions about budgeting, tax reporting, financial reporting, fraud prevention, etc.