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Everything You Need to Know About Financial Audits + 5 Steps to Prepare

Have you just been informed that you need to perform a financial audit? If so, you likely had or are planning to have a significant change occur in your company.

A financial audit is conducted by an independent accounting firm that gives you an opinion on your company’s financial standing. Ideally, your auditors will find that your financial statements are complete and accurate in all material aspects.

Regardless of your size and industry, you may need an audit for various reasons, primarily if you:

  • Are publicly held or plan to go public.

  • Accept funding from the federal or state government.

  • Received a large loan or are considered high risk by a bank.

Other instances where an audit may not be required but is beneficial include when you are:

  • Trying to get approved for a loan — an audit can be the difference between approval or rejection and a high or low interest rate.

  • Trying to raise equity or gain new investors.

But if this is your first time, preparing for a financial audit can seem overwhelming. Where do you start? Below, we’re sharing everything you need to do to get your business in the best shape for an audit, including:

  • Financial audit terms to know

  • Four types of audit findings

  • Five steps to prepare for an audit

Financial Audit Terms to Know

Below are several common terms that will come up throughout your audit process.

  • Segregation of Duties: A risk management technique in which the key functions of a process are dispersed between multiple people or departments. This separation ensures an additional layer of oversight, preventing errors and fraud.

  • Internal Controls: Processes (preferably documented) established to ensure the integrity of your financial information.

  • Materiality: The impact of an omission or misstatement of information in a company’s financial statements on the recipient of those statements (i.e., the entity requesting the audit, like your bank).

  • Independence: According to the Association of International Certified Public Accountants (AICPA), independence refers to the ability of an individual to practice integrity, objectivity, and professional skepticism. The AICPA and other governing bodies establish independence requirements for accounting professionals.

  • Trial Balance: Listing of all active accounts used in your accounting system and their balances as of your audit date.

4 Types of Financial Audit Findings

After completing an audit of your organization’s financial statements, your auditors will present you with a report along with one of four types of findings:

  • Unqualified Opinion: This is the ideal finding and means that your auditor’s opinion is that your financials are presented fairly in all material aspects and under Generally Accepted Accounting Principles (GAAP).

  • Qualified Opinion: In this case, your auditor has found a single deviation from GAAP (i.e., breaks one of the GAAP rules) or a scope limitation, meaning something is preventing them from performing their audit procedures. Your auditor must give a basis for their qualified opinion, and it’s up to the recipient of the report (e.g., your bank) to determine whether the issue impacts the usefulness of the financial statements.

  • Disclaimer of Opinion: This finding occurs when your auditor does not give any opinion about your business’s financial position, usually because they could not perform all necessary audit procedures due to client or system limitations. This “no opinion” report generally creates a negative image of the company.

  • Adverse Finding: The most concerning report and a red flag for investors, this means auditors have found that a company’s financial statements are materially misstated, should not be relied upon, and break multiple GAAP rules. An adverse finding can hurt stock prices and even prevent you from trading stocks.

5 Steps to Prepare for a Financial Audit

Now that you understand the key terms and four types of financial audit findings, you can start getting your ducks in a row for your audit.

1.Find the right audit partner.

Typically, you can choose the audit partner you work with. Consider your business size, needs, and complexity of your finances as you contemplate whether you need a small practice, an international accounting firm, or something in the middle. Start the process sooner than later because it takes time to find the right auditor!

Smaller practices are more cost-effective and provide more personalized attention. However, a small firm may not be able to handle a large capacity or meet fast deadlines. While a large firm will cost significantly more, it can handle expedited timelines and bigger workloads.

Begin by doing your research and getting recommendations from others in your industry. Next, you’ll:

  • Put out a request for proposal (RFP).

  • Review proposals as they are submitted.

  • Meet with any accounting firms who sound like they might be a good fit for your business.

Keep in mind that your auditor must be independent of your company. They can’t be related to any employees or be an investor in your business. And if you work with an external accounting firm for your day-to-day accounting and finance needs, that firm cannot also be your auditor.

2. Complete a reconciliation.

Your accountant will handle your company’s reconciliation, a crucial step in financial audit preparation.

For a successful reconciliation, all major accounts on your trial balance need supporting documentation ( e.g., bank accounts must tie to bank statements, inventory must tie to system inventory reports, payroll expenses must tie to 941 filings, etc.).

Beware of three areas of risk during the reconciliation process:

  • Overstatement of Assets: Saying you have more assets on hand than you have OR stating that the value of your assets is higher than it actually is

  • Understatement of Liability: Not accurately stating your payables or expenses as of the audit date

  • Revenue Recognition: Accurately reporting the amount of revenue your business made in the last year

3.Prepare and update internal policies and procedures.

Next, it’s time to pull together all documentation regarding your business’s internal controls. This is a good time to ensure you have the necessary accounting policies and procedures in place and well-documented for all employees to follow.

Internal controls include policies for managing:

  • Payroll

  • Fixed assets

  • Payments

  • Bank account reconciliation

  • Credit card use

Documenting these accounting and finance policies allows you to show auditors consistency in what you do and how.

4. Establish a timeline and assign responsibilities.

The bank or entity requesting the audit dictates what they need and the deadlines. Your auditors then follow GAAP and other regulations to ensure your financial statements are prepared. They will provide you with a financial audit checklist of the necessary documents and schedules, which will vary depending on your business and industry.

This checklist will include things like prepping the trial balance and gathering information on key vendor, supplier, and employee contracts. Determine due dates and designate assignments between yourself and your accounting team.

While the checklist is part of the initial audit preparation, finishing it doesn’t mean the audit is done! After receiving all requested items, auditors have to test balances and ensure they’re materially correct (i.e., performing the actual audit).

5. Gather information regarding significant company changes.

If your business underwent any significant changes in the past fiscal year — whether financial or operational — you should inform your auditor at the beginning of the process and provide them with all relevant documentation. Major changes may include:

  • Adding a new product line

  • Significant purchases (e.g., buying a new building)

  • Acquiring new debt

  • Adding or removing key organization personnel (e.g., C level employees)

These changes or transactions could result in significantly more work and a deviation from the timeline, which is why it’s vital to tell them upfront. Your board minutes will include much of this information, so be sure to provide them to the auditors.

Survive a Financial Audit

The best way to prepare your company for a financial audit is to maintain accurate, organized records year-round. Putting solid processes and procedures in place plays a critical role in keeping your finances straight and avoiding errors.

With good practices and at least a basic understanding of what goes into an audit and what to beware of, you will be equipped to survive it and grow your business.

Of course, if you are growing or have unique financial needs, this may be more challenging. And hiring an internal accounting department may not be in the budget. Hiring an outsourced accounting firm can be much more cost-effective and ensure you maintain proper accounting practices.

To learn more and discuss your options, schedule a free consultation today! Our experienced accountants will be happy to prepare you and guide you through the financial audit process.

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