In the realm of financial modeling, data visualization and communication have assumed central importance in understanding and interpreting complex financial data. One tool that has emerged as powerful yet accessible for visualizing intricate data relationships is the Sankey diagram. This guide aims to provide an in-depth understanding of Sankey diagrams, covering their theory, application, and implementation in financial modeling, along with some key best practices and considerations.
### What Are Sankey Diagrams?
Sankey diagrams, named after Captain Matthew Henry Phineas Riall Sankey, are specialized flow diagrams that represent data flow or the transmission of resources from one set to another. The key feature of these diagrams is the use of arrows or flowing lines where the width of the lines indicates the quantity of flow, making them highly effective for visualizing the balance, transformation, or redistribution of economic resources.
### Key Features and Benefits
**Visualization Clarity:** Sankey diagrams excel in providing a clear, visual representation of the flow of resources, making it easier to grasp complex financial dynamics.
**Resource Allocation Overview:** They help in understanding the allocation, use, and transformation of financial resources within organizations, industries, or over time.
**Decision-Making Insight:** By highlighting the importance of various flows or resources, Sankey diagrams aid stakeholders in making informed decisions, particularly in investment, budget allocation, or strategic planning.
### Implementation in Financial Modeling
**Step 1: Data Collection** – Gather all necessary financial data that you intend to visualize. This could include cash flows, budget allocations, or investment distributions within a company, between different departments, or across various products or services.
**Step 2: Data Structuring** – Organize your data into categories that can be logically grouped and sequenced in the flow of the Sankey diagram. For example, different departments might have inputs from sources like revenue, capital, or grants, and outputs to expenditures.
**Step 3: Design the Diagram** – Use a software tool suitable for creating Sankey diagrams. Options include Microsoft Excel, online tools like Sankey2Vis, or more specialized software such as Tableau and PowerBI, which are powerful for creating complex visualizations and linking them to data sources.
**Step 4: Customize and Enhance** – Adjust colors, labels, and arrow widths to effectively communicate the scale and nature of flows. Adding dimensions like time, location, or category can provide deeper insights.
**Step 5: Present and Analyze** – Present the Sankey diagram to stakeholders. Utilize interactive features in software like Tableau to allow users to explore different aspects of the data through drill-down and filtering options.
### Best Practices
**Simplicity First** – Focus on making the diagram as simple and clear as possible. Avoid clutter by limiting the number of categories if necessary.
**Highlight Important Flows** – Emphasize high-volume flows or critical resources to draw attention to their importance.
**Consistent Flow Direction** – Ensure all flows are consistently directed, either entirely left-to-right or top-to-bottom, to avoid confusion.
**Use Annotations** – Add labels and annotations to clarify any complex flows or data points that might not be immediately clear.
### Conclusion
Sankey diagrams provide a visual and compelling way to enhance the communication of financial data in models. By effectively using these diagrams, financial analysts, business leaders, and stakeholders can gain a deeper understanding of the nuances in financial relationships, allocation processes, and overall financial health. This guide serves as a starting point to integrate Sankey diagrams into your financial modeling toolkit for more insightful and influential presentations of data.
