SANKEY DIAGRAMS IN FINANCE: VISUALIZING THE FLOW OF CAPITAL AND INFORMATION
As finance professionals continue to seek innovative ways to analyze, communicate, and interpret the complex and multifaceted nature of financial data, one powerful tool that has emerged as a cornerstone of modern financial analysis is the Sankey diagram. These diagrams, named after English engineer WilliamPlayfair Sankey, effectively visualize the flow of materials, fluids, energy, and, increasingly, funds and information within systems and processes.
At their core, Sankey diagrams are flow charts that depict the quantity of material, fluid, or energy passing from one point to another in a process infrastructure. Their unique feature is their varying width of arrows, which accurately represents the magnitude of the flow.
In the finance sector, Sankey diagrams offer an incredible capability to visualize the flow of capital and information across various entities and channels. They provide a clear, simplified view of intricate systems and are instrumental in understanding and presenting complex financial structures and activities. Here’s why they are becoming increasingly valuable in finance:
### 1. Insights into Capital Allocation
One of the primary applications of Sankey diagrams in finance is in illustrating how capital is allocated across different segments of an organization. By mapping the inflows and outflows, financial analysts can get a detailed view of where capital is being directed, the scale of these flows, and how they evolve over time.
### 2. Energy Consumption Analysis
Sankey diagrams can also be used to reveal the energy consumption profile of an organization, providing insights into cost savings and sustainability initiatives. This dual application showcases the flexibility of these diagrams to illustrate resource flows beyond mere capital and information.
### 3. Portfolio Management
In portfolio management, investors and fund managers can use Sankey diagrams to evaluate the exposure of their portfolio to various asset classes and sectors. By tracking the distribution of assets over time, they can make more informed decisions regarding diversification and risk management.
### 4. Risk Management
For risk management professionals, Sankey diagrams are invaluable tools. They allow for the visualization of risk propagation within a system and the identification of critical points where risk is likely to be concentrated. This is particularly useful in assessing the interconnectedness of markets, which, when understood, can inform the creation of effective hedging strategies.
### 5. Business Model Analysis
Sankey diagrams can help finance teams explore different business models and their financial flows, be it for a start-up or an established enterprise. The visualization of these models aids in spotting inefficiencies or areas where additional value can be drawn.
### 6. Regulatory Reporting
Finance teams are often required to provide detailed reports to regulators regarding the movement of capital. Sankey diagrams provide a clear and compelling way to visualize these reports, ensuring that regulators can understand the complexities involved in the flow of capital without needing to delve into extensive data.
### How to Create a Sankey Diagram in Finance
Creating a Sankey diagram involves several steps:
1. **Gather Data**: Compile the data that you want to visualize. This may Include capital inflows and outflows, information streams, or the energy consumption of different segments.
2. **Identify Nodes**: Nodes are the starting and ending points of arrows and represent distinct components of the process. They should be chosen based on the specific requirements of the project.
3. **Define Arrows**: Arrows represent the flow of capital, information, or energy. The width of the arrow indicates the quantity of the flow. Ensure that you use consistent scales to convey accurate information.
4. **Draw Links and Connect Nodes**: Use links to connect nodes by drawing arrows from the output node of the first process to the input node of the next, ensuring the flow is clearly depicted.
5. **Analyze and Iterate**: Once drawn, analyze the diagram for clarity, accuracy, and insight. It’s not uncommon to need to iterate on the design to improve readability.
### Conclusion
Sankey diagrams are a valuable visual tool for the finance industry, providing a succinct visual representation of complex financial flows and systems. They enable better decision-making by highlighting patterns and trends that might be missed in traditional tabular or linear data representations. As financial landscapes continue to evolve and become more complex, deploying Sankey diagrams could become a standard practice for any serious analysis or strategic planning within finance.
