Financial Statement Analysis for Investigations

What Financial Statement Analysis Tests

A forensic review tests what the accounts say about the business and whether material assertions have support. An assertion is a claim within a reported figure, such as whether a receivable exists or inventory has a recoverable value.

Company financial statements contain accounting classifications and non-cash amounts, including depreciation and accrued expenses. Bank statements record cash movements through particular accounts. A deposit alone does not explain whether the receipt is revenue, borrowing or a transfer.

Use both sets of records. Bank activity helps test cash movements, while invoices, journals and other accounting records explain recognition and classification. Neither set substitutes for the other. Source-statement arithmetic belongs in the separate bank statement reconciliation process.

Read the Statements as a Connected Set

Read each statement for its different time basis, then connect its figures to the other statements and notes.

Statement	What it reports	Investigation question
Income statement	Revenue and expenses over a period, producing profit or loss	Were sales earned in this period and expenses recorded in the right period?
Statement of financial position, also called the balance sheet	Assets, liabilities and equity at a point in time	Do the reported assets exist and are liabilities complete?
Cash-flow statement	Cash movements over a period, classified by activity	How did the company fund its spending and where did its cash go?
Statement of changes in equity	Movements in equity over a period	How do profit, distributions and capital movements explain the closing equity?

Other comprehensive income, where applicable, also forms part of the statement set. The Australian Securities and Investments Commission (ASIC) explains the components of financial reports, including notes and the accompanying reports.

Before calculating ratios, identify the entity and reporting period. Confirm the comparative period’s length, presentation currency, accounting basis and consolidation scope. Group accounts combine entities and eliminate some transactions between them. They cannot establish a particular subsidiary’s standalone position without its own records.

Establish the Australian income year using the ATO’s standard-period and substituted-period guidance. An approved substituted accounting period uses a different annual boundary. Obtain the approval and match its start and end to the statements, comparatives and bank records. Confirm the company’s financial-reporting period separately. A transition period of different length can distort annual ratios.

Read the accounting policies and estimates with the numbers. Review related-party notes, commitments and any director or auditor reports applicable to that entity. A qualification can affect the conclusion drawn from an entire balance or period.

An unmodified audit opinion does not establish that every payment was authorised. ASA 200 describes reasonable assurance about material misstatement, with inherent limits to an audit. Transaction authority requires evidence specific to the payment.

Profit measures performance across the period. The balance sheet shows what remains at its end, while the cash-flow statement explains the movement in cash. Credit sales can increase profit before customers pay, allowing profit and falling cash to occur together.

A Financial Statement Analysis Example

This fictional small trading company shows how the statements connect over one 365-day reporting period in 2026. Assume it voluntarily prepares accrual general purpose accounts using Tier 2 simplified disclosures. Assume it has not early adopted AASB 18. Its size alone does not establish a reporting obligation.

The tables are analytical extracts, not a complete statutory financial report. They assume no asset disposals, capital contributions, other comprehensive income or non-cash borrowing. Other tax and interest timing adjustments are nil. The reported revenue and receivables use the same tax basis.

Income statement item	Amount
Revenue	$1,000,000
Cost of sales	($600,000)
Gross profit	$400,000
Other expenses, including any tax expense	($280,000)
Depreciation	($20,000)
Net profit	$100,000

Depreciation is included in the total $900,000 of expenses. The company records $30,000 of capital expenditure, so property, plant and equipment rises from $200,000 to $210,000 after depreciation.

Financial-position item	Opening	Closing
Cash	$20,000	$35,000
Receivables	$100,000	$160,000
Inventory	$80,000	$90,000
Property, plant and equipment, net	$200,000	$210,000
Total assets	$400,000	$495,000
Payables	$60,000	$65,000
Loans	$140,000	$170,000
Total liabilities	$200,000	$235,000
Equity	$200,000	$260,000
Total liabilities and equity	$400,000	$495,000

Both balance sheets balance. Opening net assets are $400,000 less $200,000, giving $200,000 equity. Closing net assets are $495,000 less $235,000, giving $260,000 equity.

New borrowing of $50,000 less $20,000 of principal repayments explains the $30,000 loan increase. Opening equity of $200,000 plus $100,000 profit less $40,000 owner distributions explains closing equity of $260,000. The distributions reduce equity and cash, without becoming an expense in this example.

Explain the Profit-to-Cash Difference

The indirect method starts with accounting profit and adjusts it for non-cash items and working-capital changes. AASB 107 explains that method and the operating, investing and financing categories.

For this small business cash flow statement example, net income means the same $100,000 net profit shown above. Depreciation reduced profit without using cash in this period, so add it back. Increased receivables and inventory absorb cash relative to profit, while increased operating payables defer payment.

Operating cash-flow bridge	Amount
Net profit	$100,000
Add depreciation	$20,000
Less increase in receivables	($60,000)
Less increase in inventory	($10,000)
Add increase in payables	$5,000
Operating cash flow	$55,000

Cash-flow activity	Calculation	Net amount
Operating	Profit-to-cash bridge	$55,000
Investing	Capital expenditure	($30,000)
Financing	$50,000 borrowing less $20,000 repayments and $40,000 distributions	($10,000)
Increase in cash	$55,000 less $30,000 less $10,000	$15,000
Opening cash	Agreed starting balance	$20,000
Closing cash	$20,000 plus $15,000	$35,000

In an actual investigation, agree both cash balances to the general ledger and bank records, with reconciliation items explained. Trace the equipment payment, loan proceeds, principal repayments and distributions to their records. The fictional example supplies those records as assumptions, not evidence from a real company.

Free cash flow here means operating cash flow less the stated capital expenditure: $55,000 less $30,000 equals $25,000. It excludes the financing payments. State that definition because analysts use different free-cash-flow measures.

Business cash flow analysis now gives specific questions. Obtain collection evidence for receivables, inventory support for stock growth, lender records for borrowing and authority for distributions. Positive profit and a $15,000 cash increase alone do not establish that cash is available when debts fall due.

Use Financial Ratios as Questions to Test

Calculate ratios using consistent periods and definitions, then connect each result to a source-record question. The following calculations use the fictional company’s figures.

Ratio	Calculation	Result	Source question
Net profit margin	$100,000 / $1,000,000	10%	Which expenses explain the movement against the comparator?
Gross margin	$400,000 / $1,000,000	40%	Are purchase costs, inventory movements and sales cut-off supported?
Current ratio	$285,000 current assets / $105,000 current liabilities	2.71	Are debt terms and current classifications correct?
Debtor days	$130,000 average receivables / $1,000,000 credit sales × 365	47.45 days	Which balances are overdue, disputed or collected later?
Operating cash flow to net income	$55,000 / $100,000	55%	Why did $45,000 of profit not become operating cash?
Operating cash flow to sales	$55,000 / $1,000,000	5.5%	Did customer collections lag recognised sales?
Free cash flow to sales	$25,000 / $1,000,000	2.5%	Is the $30,000 capital expenditure supported and appropriately classified?

Assume a fictional prior-period net margin of 12% on a comparable basis. The current 10% is two percentage points lower. Compare expense categories and one-off entries before attributing the movement to trading performance. Gross margin uses profit before other expenses, so it cannot substitute for net margin.

For the closing current ratio, assume $40,000 of the $170,000 loan balance is current and $130,000 is non-current. Current assets are cash, receivables and inventory. Current liabilities are $65,000 payables plus $40,000 current borrowing.

Overdue receivables can overstate near-term resources. Restricted cash can inflate the apparent funds available for debts, while wrongly classifying a callable loan can understate current liabilities. Read the agreement and relevant classification requirements before accepting 2.71 as reassuring.

Debtor days assumes all $1,000,000 of revenue is credit sales over 365 days. Average receivables are ($100,000 + $160,000) / 2, or $130,000. Using only closing receivables would give 58.4 days and answer a different question. Seasonal sales can make even a two-point average unrepresentative. If sales include cash sales, use credit sales in the denominator.

Operating cash flow to net income compares cash generation with profit, but becomes undefined at zero profit. A negative profit can reverse its sign and obscure interpretation. Discuss the underlying amounts in those cases. The sales-based ratios also require nonzero sales and matching periods.

If a report uses “cash return on sales”, state its actual numerator and denominator. Here, operating cash flow divided by revenue is 5.5%. A measure using another cash numerator needs a different explanation. Working-capital timing changes operating cash ratios, while capital expenditure also changes free cash flow.

Food-cost and overhead percentages

A useful food-cost or overhead percentage depends on the business model and the expenses included. In a separate fictional restaurant schedule, annual revenue excluding GST is $1,000,000. The schedule records food consumed at $300,000, payroll at $400,000, defined overheads at $150,000 and other expenses at $50,000. These expenses total $900,000, leaving $100,000 profit.

Food cost divided by revenue is $300,000 / $1,000,000, or 30%. Here, food consumed includes opening stock plus purchases less closing stock. Defined overheads comprise premises costs, utilities, insurance and administration, with payroll recorded separately. Overheads divided by the same revenue are $150,000 / $1,000,000, or 15%.

Use the ATO’s industry benchmark data to select a restaurant comparator in the corresponding turnover band. Retain the dataset’s reporting year and its definition of each expense ratio. A food-only numerator cannot be compared directly with cost of sales that includes other items. The fictional 15% overhead measure also differs from total expenses.

Compare dine-in and takeaway activity, beverage sales and outsourced services before treating a range as useful. Check stock movements, invoice cut-off and the expense classification behind any difference. An unusual percentage identifies a source-record question. It does not prove fraud or poor management.

Charity administration percentages

Identify the charity, reporting period and published expense categories before calculating an administration share. The Australian Charities and Not-for-profits Commission (ACNC) explains that different charities classify similar costs differently. Their operating models also differ. A universal administration percentage cannot establish whether funds were misused.

For an actual classification example, Australian Red Cross Humanitarian Services reports $253.3 million of expenditure for 2025–26. Its annual report’s expenditure breakdown separately identifies $147.2 million of program spending and $19.3 million of fundraising and marketing. Shops, first aid training and disability services account for $42.2 million. Property maintenance, lease and administration are grouped at $44.6 million.

The combined property, lease and administration category is $44.6 million / $253.3 million, or approximately 17.6% of that division’s expenditure. This calculation measures the published combined category. Administration alone remains unquantified in that breakdown. Using total Society expenditure as the denominator would mix the division with Lifeblood.

To isolate administration, obtain the underlying financial statements and notes, then the allocation schedule supporting the combined category. Test shared staff time and premises allocations against source records. Keep program delivery and fundraising costs distinct under the charity’s own definitions. If the records do not separate administration, retain that limitation instead of inventing the split.

No ratio threshold alone proves fraud, insolvency or business value. ASIC’s insolvency guidance focuses on paying debts when due. Keep that separate legal assessment within the insolvent-trading inquiry.

Tie Material Balances to Their Source Records

Prioritise material and disputed balances, then match each accounting assertion to records capable of testing it.

Balance or transaction	Supporting records	What the test must distinguish
Cash	Bank statements and reconciliations	Recorded balance, ownership, restrictions and available funds
Receivables	Aged ledger, invoices and subsequent receipts	Existence and collection, with separate valuation and cut-off tests
Revenue	Contracts, sales invoices and delivery or performance records	Recognition period and whether the earning activity occurred
Inventory	Count sheets, movement records and valuation evidence	Quantity, ownership and recoverable carrying amount
Borrowing	Lender statements, agreements and repayment terms	Outstanding principal, security, restrictions and maturity
Related-party balances	Agreements, ledger history and approvals	Counterparty, purpose, terms and authority

Later collection supports the existence of a receivable but does not establish correct revenue cut-off. A customer could pay an invoice raised before the service was performed. For professional fee revenue, compare the engagement and work completed with the recognition policy, not just the payment date.

Preserve full ledger history, including reversals and entries that contradict the proposed explanation. The general ledger guide covers the separate posting-history reconstruction behind a disputed balance. A bank payment confirms a recorded cash movement. Its classification and commercial purpose require other evidence. Financial-record retention is addressed separately under section 286 records.

Use a worksheet with distinct fields so an inference cannot silently become an established fact.

Worksheet field	Fictional receivables example
Assertion	The sale belongs in this reporting period and remains collectible
Reported amount	$20,000 within closing receivables
Supporting record	Sales invoice and later bank receipt
Observed discrepancy	Customer pays after period end, but performance evidence is absent
Proposed explanation	Work was completed before period end and payment followed later
Unresolved question	Which work record establishes completion before period end?

A Financial Statement Disclosure Checklist

Apply a disclosure checklist to the entity’s reporting obligations and framework. AASB 1060 contains simplified disclosures for Tier 2 entities. Other entities and reporting bases require their own applicable requirements.

This forensic checklist directs follow-up work. It is not an exhaustive compliance checklist or a rule that every small company must make identical disclosures.

Review area	Disclosure question, where applicable	Source-document follow-up
Entity and basis	Are the reporting entity, group boundary and accounting basis explained?	Obtain the entity structure and preparation instructions
Policies and estimates	Are material policies and relevant estimation uncertainty explained?	Obtain calculations and evidence for the disputed estimate
Related parties	Do disclosures explain relevant relationships, transactions and balances?	Obtain agreements and approvals for disputed entries
Debt terms and restrictions	Are relevant security, defaults or restrictions disclosed?	Obtain lender terms and correspondence
Contingent items and commitments	Are applicable contingencies and commitments addressed?	Obtain contracts or claims supporting the treatment
Going concern	Are applicable material uncertainties and the preparation basis explained?	Obtain forecasts, debt schedules and funding support

An absent required disclosure and an unavailable underlying document are different problems. For an unexplained related-party balance, ask the preparer which disclosure requirement applies and where it is addressed. If the note exists but the agreement is missing, ask what evidence supports the stated terms.

A document request must follow the engagement and applicable legal process. The checklist itself creates no right to compel production.

Handle Missing Records and Contradictory Accounts

A reconstructed cash history cannot by itself produce complete accrual accounts. Bank records do not capture every unpaid liability, non-cash journal, inventory adjustment or opening balance.

If an account shows a supplier payment, the evidence may support several treatments. It could settle an opening payable, buy inventory or pay a current expense. Retain those alternatives until invoices and ledger history establish the treatment. Unsupported amounts remain unresolved instead of defaulting to zero.

Where records remain missing, the instructed accountant can qualify a conclusion or show sensitivity to alternative treatments. For example, show how an unsupported receivable affects the current ratio if it is recoverable and if it is written down. Non-financial information, including delivery logs and inventory counts, can resolve questions cash records leave open.

Finish the analysis with an ordered verification sequence.

1. Confirm that each balance sheet balances and equity movements explain closing equity.
2. Reconcile opening and closing cash, including the operating, investing and financing movements.
3. Reproduce every formula using the stated period and assumptions.
4. Match material assertions to sources and retain contradictory evidence.
5. Keep unresolved items visible in the report and explain their effect on the conclusion.

Hand the Evidence to the Responsible Professional

Give the instructed accountant or insolvency practitioner a traceable record of the cash movements alongside the accounting evidence. The bank-record preparation guide explains how to organise that source package.

FinTrace’s bank-statement analysis service saves hours of statement conversion and review, giving forensic accountants more time for interpretation. You receive a categorised, searchable Excel ledger and clear findings with source PDF filenames and pages. Those records support cash-side checks and keep the underlying evidence at hand.

The accountant interprets the financial statements and forms the professional accounting opinion. The lawyer handles rights and legal issues. A complete accrual analysis also requires the non-cash records and liabilities described above.

Valuation Questions and Banking-Company Statements

Financial statement analysis informs valuation through normalised earnings and the assets, debt and working capital behind them. Adjustments need a stated rationale and evidence. Ratios alone do not produce a business valuation. A valuation assignment requires a defined purpose and an appropriately qualified methodology.

Banking-Company Illustration

In a separate fictional bank, a $1,000 customer loan is a loan asset and the interest earned is income. Receiving a $1,000 customer deposit creates a liability because the bank owes the customer that amount. These are the bank’s own company accounts. The customer’s bank statement records activity in the customer’s account.

Bank analysis also requires the relevant Australian Prudential Regulation Authority (APRA) capital and liquidity context. APRA explains how bank liquidity requirements address the ability to meet obligations. Leave prudential conclusions to an appropriately instructed banking specialist.

Financial Statement Analysis Report Structure

Use a report structure that lets another professional follow the calculation and challenge the explanation.

1. Identify the entity, group scope, reporting period and accounting basis.
2. Set out the calculations, definitions and example assumptions used.
3. Record source tests and discrepancies beside the relevant assertions.
4. Present competing explanations and unresolved records, including their effect on conclusions.
5. State the accounting conclusions within the engagement’s scope and identify any separate valuation or legal questions.

Before handing over the report, ensure its material conclusions lead back to the calculations and source records that support them.