What is Financial Analytics? Why is it Useful for Businesses?

what is financial analytics and its use in businesses

Pradhumnya Khanayat 19/02/2024

In today’s competitive business environment, data-driven decision-making has become essential for organizations to stay ahead. The global big data and business analytics market is projected to reach $684.12 billion by 2030, highlighting the increasing significance of leveraging data for business success (Allied Market Research). Financial analytics, also known as finance analytics, plays a crucial role in providing insights into a company’s financial data to facilitate strategic decisions and enhance overall performance. In this article, we will explore what financial analytics is with examples, its importance for businesses, the types of financial data analyzed, tools and techniques used in financial analytics, and future trends and career opportunities in this field.

What is Financial Analytics?

Financial analytics involves analyzing historical financial data to identify trends and patterns that can inform decision-making (Teradata). For instance, analyzing sales data can help determine the impact of marketing campaigns on revenue. It encompasses various types of financial data such as financial statements (income statement, balance sheet, cash flow statement), key performance indicators (KPIs) and metrics, as well as market and industry data.

Let’s consider an example of how financial analytics can be applied in practice. A retail company wants to determine the profitability of its brick-and-mortar stores versus its online platform. By analyzing financial data such as sales revenue, operating costs, and customer acquisition costs for both channels, the company can gain insights into which channel is more profitable and make informed decisions regarding resource allocation and expansion strategies.

Importance of Financial Analytics

Financial data analytics offers several contributions to the betterment of overall business performance. Some of the benefits of financial analytics are:

Improved Decision-Making: Financial analytics offers insights from historical data, aiding informed decision-making and identifying growth opportunities.
Enhanced Financial Planning and Forecasting: It helps identify key performance drivers, facilitating accurate budgeting and resource allocation for future periods.
Effective Management of Tangible Assets: Financial analytics enables the optimization of assets like cash flow and equipment, reducing costs and improving profitability.

Types of Financial Data Analytics

Finance and business analytics encompasses three main types: descriptive analytics, predictive analytics, and prescriptive analytics.

Descriptive Analytics: Descriptive analytics involves summarizing historical financial data to understand past performance. This type of financial data analytics includes generating financial reports and dashboards that provide a comprehensive view of the company’s financial status.
Predictive Analytics: This type of financial services analytics uses historical data and statistical models to forecast future financial outcomes (eCapital). By identifying patterns in historical data, businesses can predict future sales, expenses, and market trends. This enables more accurate financial planning and decision-making.
Prescriptive Analytics: Prescriptive analytics recommends optimal courses of action based on data analysis. It goes beyond descriptive and predictive analytics by providing actionable insights that drive decision-making.

Methods Used in Financial Analytics

Financial analysts utilize a diverse range of methods to extract valuable insights from financial data. Here are some key methods commonly employed:

1. Descriptive Analytics:

Horizontal Analysis: Compares financial data across different periods, typically year-over-year, to assess trends and growth rates. (Example: Comparing annual revenue to understand growth patterns)
Vertical Analysis: Expresses each line item in a financial statement as a percentage of a base figure, enabling proportional analysis. (Example: Expressing cost of goods sold as a percentage of revenue)
Common-Size Statements: Presents financial statements as percentages of total assets or total liabilities, allowing comparisons across companies of different sizes.

2. Diagnostic Analytics:

Ratio Analysis: Calculates ratios based on financial statement data to assess various aspects of a company’s performance, such as profitability, liquidity, efficiency, and solvency. (Examples: P/E ratio for valuation, current ratio for liquidity)
Trend Analysis: Analyzes trends in financial data over time to identify patterns and potential causes of performance changes.
Variance Analysis: Compares actual financial results to budgeted or expected values to identify and explain deviations.

3. Predictive Analytics:

Financial Modeling: Creates mathematical models to simulate financial outcomes under different scenarios, forecasting future performance.
Regression Analysis: Identifies statistical relationships between variables, enabling predictions based on historical data.
Machine Learning: Uses algorithms to learn from historical data and make predictions about future events, often focusing on complex patterns that might be missed by traditional methods

Other Methods:

Data Visualization: Presents financial data in charts, graphs, and dashboards to facilitate clear communication and understanding of insights.
Monte Carlo Simulation: Analyzes the impact of uncertainty on financial models by running multiple simulations with different random inputs.
Scenario Planning: Identifies and assesses potential future scenarios to help organizations prepare for contingencies.

Tools and Techniques used in Financial Analytics

Financial analytics relies on various tools and techniques to collect, integrate, analyze, and visualize financial data.

Data Collection and Integration: Gathering relevant financial data from various sources is a crucial step in financial analytics. This includes extracting data from financial systems, external databases, and market sources. Financial analytics tools like Extract, Transform, Load (ETL) enable organizations to integrate data from different sources for comprehensive analysis.
Data Visualization and Reporting: Converting complex financial data into meaningful visual representations is essential in financial analytics. Data visualization tools such as Tableau or Power BI help transform raw financial data into interactive charts, graphs, and dashboards that facilitate understanding and decision-making. These visualizations can be used for reporting insights to stakeholders or for internal analysis.
Predictive Modelling and Forecasting: Financial analytics utilizes statistical techniques to build predictive models and forecast future financial outcomes. Machine learning algorithms can be applied to historical financial data to identify patterns and make accurate predictions. Forecasting revenue, expenses, and market trends enables better financial planning and risk management.

Here are some Financial Analytics case studies for you:

Amazon Case Study
Hertz Global Case Study
Manchester United Case Study

Real-World Applications of Financial Analytics

Financial analytics are extensively utilized in various real-world scenarios, such as investment banking. Here are some examples:

Investment Analysis: Analysts utilize financial analytics to evaluate market trends, assess security performance, and identify potential investment opportunities. Methods such as regression analysis and financial modeling aid in predicting stock prices and assessing returns and risks associated with investment strategies.
Risk Management: Financial institutions use analytics to monitor and mitigate risks across portfolios, employing scenario analysis to evaluate potential market downturns’ impact and adjust risk exposure accordingly.

Thus, financial analytics enable organizations to make data-driven decisions, optimize performance, and achieve strategic objectives amidst evolving market dynamics.

Real world Examples of Financial Analytics

1. Retail Giant Optimizes Inventory Management:

Challenge: Managing high inventory levels led to wasted resources and decreased profitability.
Solution: Implemented analytics to track sales trends, predict demand, and optimize stock levels across different regions and stores.
Impact: Reduced inventory by 20%, improved cash flow, and increased profitability by 5%.

2. E-commerce Platform Personalizes Pricing:

Challenge: Maximizing revenue while maintaining customer satisfaction.
Solution: Used dynamic pricing algorithms that consider customer demand, purchase history, and competitor pricing to set personalized prices.
Impact: Increased revenue by 8% while maintaining high customer satisfaction ratings.

3. Airline Determines Profitable Routes:

Challenge: Identifying which routes were most profitable and which needed adjustments.
Solution: Analyzed historical data on passenger bookings, fuel costs, and operational expenses to assess performance per route.
Impact: Discontinued unprofitable routes, optimized schedules, and increased overall profitability by 10%.

4. Manufacturing Company Predicts Machine Failures:

Challenge: Minimizing downtime due to unexpected equipment failures.
Solution: Implemented sensor-based data collection and analytics to predict machine failures and schedule preventive maintenance.
Impact: Reduced downtime by 30%, improved production efficiency, and lowered maintenance costs.

Career Opportunities in Financial Analytics

Career opportunities in financial analytics are burgeoning in India, driven by increasing demand for data-driven insights across industries. The job outlook for professionals in this field is promising, with a growing need for skilled analysts to interpret complex financial data and guide strategic decision-making.

Salaries in financial analytics are competitive, with entry-level positions offering around INR 5-7 lakhs per annum, and experienced professionals earning significantly higher, sometimes exceeding INR 15 lakhs per annum.

To excel in a financial analytics role, individuals need a strong foundation in finance, statistics, and data analysis. Proficiency in programming languages like Python and R, along with expertise in data visualization tools such as Tableau or Power BI, is also crucial. Pursuing degrees or certifications in finance, business analytics, or data science can help professionals upskill and secure their careers in advanced financial analytics. Institutions like the Indian Institute of Management (IIMs) and the Indian School of Business (ISB) offer specialized financial analytics programs tailored to meet the growing demand for skilled financial analysts in the Indian job market.

Conclusion

In conclusion, financial analytics is a crucial tool for businesses in today’s data-driven world. By analyzing historical financial data, organizations can gain valuable insights that inform decision-making, enhance financial planning and forecasting, and optimize the utilization of tangible assets. As the demand for skilled professionals in data analytics for financial services continues to grow, it is essential for individuals to develop expertise in this field to unlock career opportunities and contribute to business success.

FAQs

1. What is financial analytics?

Financial analytics involves analyzing historical financial data to gain insights that inform strategic decision-making and improve overall business performance.

2. Why is financial analysis important?

Financial analysis is important because it enables businesses to make informed decisions, enhances financial planning and forecasting, and optimizes the management of tangible assets.

3. What are the types of financial data analytics?

The types of financial data analytics include descriptive analytics, which summarizes historical data; predictive analytics, which forecasts future outcomes; and prescriptive analytics, which recommends optimal courses of action.