An improved method to identify the crack location and size is presented which takes advantages of wavelet finite element (WFE). The important property of wavelet analysis is the capability to represent functions in a dynamic multiscale manner, so solution with WFE enables a hierarchical approximation to the exact solution. WFE has good ability in modal analysis for singularity problems like a cracked beam. The crack in a beam is modeled with WFE and represented as a rotational spring. The additional flexibility caused by crack in its vicinity is evaluated according to linear and elastic fracture mechanics theory. The WFE stiffness matrix of the crack is constructed and the algorithm for crack identification through the use of vibration-based inspection (VBI) is developed. With the accurate natural frequencies obtained from the transient signal measured, graphs of crack equivalent stiffness versus crack location are plotted, by providing the first three natural frequencies as an input. The intersection of the three curves gives the crack location and size. Experimental studies of cracked shafts are presented to demonstrate the accuracy of the method. The error in identification of crack location and size are both less than 2%. This study provides the new method for the diagnosis of incipient small crack.