Fluctuation Analysis Accounting: Key Steps and Best Practices for Finance
Learn how to apply fluctuation analysis in accounting to identify trends, improve financial accuracy, and support better decision-making processes.
Fluctuation analysis is a technique used in finance and accounting to identify unexpected changes in financial data. By comparing figures across different periods or against established benchmarks, finance teams can spot trends, detect errors, and uncover potential risks promptly. In today’s business environment, where accuracy and timely insights are valued, understanding fluctuation analysis is helpful for maintaining financial controls.
This article explores the elements of effective fluctuation analysis, offering practical steps and best practices for conducting reviews.
Instances for Using Fluctuation Analysis
Fluctuation analysis is applied in various financial contexts, primarily to compare account balances between reporting periods, such as monthly, quarterly, or annually. This comparison helps identify deviations in financial data over time across the main financial statements: the income statement, balance sheet, and cash flow statement. Examining these statements provides insights into performance trends, financial position, and cash management.
One common application is during the financial close process. After completing period-end procedures, fluctuation analysis serves as a quality check to help verify data accuracy. It can highlight potential accounting errors, like missing data or incorrectly recorded transactions, and may point to unusual activity requiring further investigation.
The technique is also integral to budgeting and forecasting. Comparing actual results against budgeted or forecasted figures, often called variance analysis, allows organizations to understand performance deviations. This understanding informs future planning, refines budgeting processes, and supports management decisions regarding resource allocation or strategy. Identifying the reasons for variances, whether internal or external, is a key objective.
Auditors frequently use analytical procedures, which include fluctuation analysis, throughout an audit. As outlined in auditing standards like the American Institute of Certified Public Accountants (AICPA) AU-C Section 520, these procedures involve evaluating financial information by studying plausible relationships among data.1American Institute of Certified Public Accountants. AU-C Section 520, Analytical Procedures They are employed during planning to understand the client’s business and identify risks, as substantive tests to gather evidence, and near the audit’s conclusion to form an overall opinion.2Public Company Accounting Oversight Board. AS 2305: Substantive Analytical Procedures Investigating significant fluctuations identified through these procedures is a standard part of the audit process.
Main Components to Focus On
When performing fluctuation analysis, attention typically centers on specific components within the financial statements. On the income statement, revenue figures are often a starting point to understand sales performance. Cost of Goods Sold (COGS) and gross profit are also examined, as changes here impact profitability and can signal shifts in production costs or pricing. Operating expenses, including selling, general, and administrative (SG&A) costs, are reviewed to assess cost control.
On the balance sheet, accounts such as cash, accounts receivable, and inventory warrant review. Changes in accounts receivable might relate to revenue shifts or credit policies, while inventory changes often correlate with COGS and sales. Examining accounts payable can offer insights into purchasing and payment terms. Movements in significant assets like property, plant, and equipment (PP&E), along with associated depreciation, and changes in debt or equity accounts also require analysis.
The concept of materiality guides the focus within these components, helping determine which fluctuations are significant enough to investigate. Materiality involves assessing whether a change could influence the decisions of financial statement users. While thresholds vary, often based on percentages of benchmarks like net income or total assets, professional judgment is applied. Analysts also consider how different accounts interact, such as the relationship between sales growth and accounts receivable, or inventory levels and cost of goods sold.
Steps in Conducting the Analysis
Conducting a fluctuation analysis begins with gathering the necessary financial data for the current period and the comparative period (e.g., prior month, quarter, year, or budget). Ensuring the reliability of this underlying data is an important preliminary step.
Once data is assembled, the next action involves calculating the differences for selected accounts. This typically includes both the absolute dollar change and the percentage change. Examining both provides context, as a large percentage change on a small base amount might be less significant than a smaller percentage change on a large base.
With variances calculated, the focus shifts to identifying which fluctuations require further investigation. This often involves comparing the variances against predetermined thresholds or expectations. The goal is to pinpoint differences considered significant or material based on the account’s nature and the company’s context.
The core of the analysis lies in investigating these identified fluctuations to understand their root causes. This requires moving beyond the numbers to ask “why” the change occurred and gathering evidence. This might involve inquiries with relevant personnel, examining underlying transaction details (like invoices or contracts), reviewing journal entries, or analyzing related operational data.
Finally, explanations obtained for significant variances need corroboration. An explanation from management is a starting point but should ideally be supported by additional evidence. The objective is to gain reasonable assurance that the explanation is accurate or to identify potential errors needing correction. This structured process of calculation, identification, investigation, and corroboration forms the basis of the analysis.
How to Document Findings
Documenting the findings from a fluctuation analysis provides a record of the work performed and conclusions reached. This documentation supports the analysis, facilitates review, and creates a trail explaining significant changes. Clear documentation ensures the reasoning behind investigating certain fluctuations is evident.
The documentation should be detailed enough for an experienced individual, unfamiliar with the specific analysis, to understand the work performed and the basis for conclusions. This principle aligns with guidance found in auditing standards like AICPA’s AU-C Section 230, Audit Documentation.3American Institute of Certified Public Accountants. AU-C Section 230, Audit Documentation The documentation should identify the accounts analyzed, periods compared, calculated variances, and the threshold used for significance.
For each significant fluctuation investigated, the documentation needs to record the explanation obtained, detailing inquiries made, individuals consulted, records examined, and corroborating evidence gathered. Referencing specific supporting documents allows reviewers to trace conclusions back to the source. Simply stating “variance investigated, no issues found” is generally insufficient.
Maintaining consistency in format and detail helps ensure all significant variances are addressed appropriately. The record should clearly state the conclusion regarding the fluctuation – whether it was deemed reasonable or indicated a potential issue requiring further action. This documented conclusion is a key part of the financial review process. While oral explanations can clarify written records, they typically do not suffice as standalone documentation.