Financial Audit! The word can start bringing anxiety attacks for a lot of businesses. The night sweats, heart palpitation and existential crisis are quite normal but we are here to tell you that it doesn’t have to be like that at all. It might be daunting and usually is time intensive as well, but it does come with the territory. Trust us when we say this, it’s entirely possible to operate your business and manage your finances to be audit ready for any situation.
But what is financial auditing? Why is this such an important process in your business?
Let’s find out.
Financial Audit:
As the name suggests, it’s a thorough and detailed examination of a company’s financial statements and accounts.It’s usually conducted annually and depending upon the audit, there are pretty common outcomes that comes out of this whole process:
1: The company has represented its financial operations correctly
2: The company’s accounting practice contains significant errors.
3: The financial records are not aligned with GAAP and it is misstated
4: There are insufficient financial statements or lack of cooperation from the company.
Usually we suggest you fall in the first category but if the end result of the audit falls under the 2nd, 3rd or 4th category, then you are in trouble. We are here to make sure that doesn’t happen.
The first question you need to ask yourself, what triggers these financial audits?
Financial Audit Triggers:
When you incorporate your company, it can operate for some time with a simple bookkeeping system. In this scenario, usually your accounting work will incorporate tracking company progress and how much cash is burned in expenses. Once you get that sweet Series A funding however, things get a little complicated because your investors want to know whether the money they have invested is going in the right direction or not. This usually includes stock based compensation expenses in accordance with GAAP. This will give them a clear understanding whether your company is ready for the next level of investment or is it time for exit. The other scenarios where you might need to think about the auditing process is preparation for initial public offering, securing a bank loan or line of credit.
The question might have come to your mind now. “Wait a minute, is it similar to a review or a compilation?”
We would say “No, they are different!”
You might ask “How?”
Let us tell you how!
The difference between Audit, Review and Compilation:
Audit:
Audit is more comprehensive in its assessment which usually involves independent, internal, detailed evaluation of an organization’s financial statements and records. Here the primary objective is to check and verify the reported data and see whether they are accurate, reliable and adheres to the accounting standards of GAAP or IFRS.
Review:
This is less extensive than your auditing process but it does give you a meaningful level of scrutiny. Usually for review, an accountant or other qualified professionals examines financial statements to make sure they align with applicable standards and do not have any misstatements. Like we said, it’s not as extensive as audit but it does give some degree of confidence in the accuracy and integrity of the financial data and can make the auditing process more simple and efficient.
Compilation:
Of all the three processes, this one is the simplest of all. It involves collecting and organizing financial data in a clear and presentable format without performing any sort of analysis or testing or accuracy procedure. This does not need any verification data by the CPA as its pure data, but in a presentable manner.
But is there only one type of auditing?
No our fellow readers, there are 3 types of auditing that’s usually conducted in businesses
Let us give you a breakdown of them
Types of Auditing:
Audit comes in various shapes and sizes but usually depends upon who is conducting them and what kind of objectives they want to achieve.
Here are the 3 main types of auditing that you should know:
Internal Audit:
This is usually conducted by professionals in the organization itself, either by a single individual or an internal audit team. The goal is here to evaluate and enhance the internal controls, improve the financial operations and most importantly, to make sure that the financial records are compliant with internal policies and procedures. They usually focus on identifying inefficiencies, fraud risks or any operational weaknesses. Post audit, they provide recommendations for process improvements and enhancement of controls. Typically these audits are ongoing or sometimes it might be triggered by specific events.
External Audit:
These are the independent third party auditors or firms who conduct a thorough audit of the business. They typically provide an objective review of the organization’s financial statements to confirm their accuracy, fairness and compliance with accounting standards such as GAAP or IFRS. Usually, they are conducted to provide a comprehensive view of the financial view of the business to regulatory bodies, investors or lenders for compliance purposes. Their main goal is to provide a high level assurance to external stakeholders and its done by providing detailed verification of financial records and transactions.
IRS Audit:
Also known as the “Big Guns” of the financial spectrum, it is conducted by the Internal Revenue Services of the United States to examine a taxpayer’s financial records and ensure that the reported tax returns comply with the tax laws. This type of audit is usually initiated due to any discrepancies, errors or red flags in tax filings. They usually focus only on tax related transactions and returns. Remember, their audits usually get triggered randomly due to specific issues such as underreporting income or excessive deductions. If you clear, it’s great, but if you don’t then you might need to do tax adjustments, face penalties or interest charges.
Financial Audit Checklist:
These all might sound really overwhelming but don’t worry, we are here to help you. Here is a checklist we have prepared just for you:
- Auditors Assemble:
Yes, as the Captain America of your company, you need Avengers level auditors in your internal audit team. They can comprise of:
- Internal auditors
- External auditors
- Financial Analysts
- Subject Matter Experts (Only if Needed)
- Update Internal Controls:
Here is what you need to do when it comes to updating internal controls. Start by assessing your current internal controls. Once done, start updating the procedure to address gaps or inefficiencies. Always make sure that controls are well documented, understood and consistently applied by employees.
- The Collection of Documentation:
As we have stressed in so many of our blogs, Documentation is really important when it comes to managing your financial teams. Usually these financial documentation includes:
- Financial statements
- Transaction records
- Invoices and receipts
- Contracts and agreements
- Risk Assessment:
Let us say this out loud, failing the audit will have huge ramifications. There we said it! Don’t worry, this can be very well avoided if you perform risk assessments in and around your financial operations. This is a proactive process and it should happen regularly. Miss a day and the IRS comes knocking on your door.
- Mock Audit:
Have you seen lawyers who conduct mock trials to understand the ins and outs of the process, understand the weaknesses and prepare themselves for any unexpected surprises? Just like that, you also need to conduct a mock audit internally to walk through the entire audit process, test for weakness and gaps, and prepare employees for real audit scenarios. Even though it’s a mock up scenario, don’t hold back and make sure you don’t leave any stones unturned.
How Long Do Financial Audits Take?
Usually financial audits can take from a few weeks to several months. Depending upon the size of the business, discrepancies in the records or the complexity of the financial records. In case of small businesses however, it takes give or take 3 months. There is a way to reduce it though. Let us tell you how.
Preparing for your financial audit should never be a year end activity. It’s something that should happen regularly and during financial operations. Here are some key steps to make this an every day habit to ensure you are audit ready:
- Make sure all the invoices, bills, contracts and other supporting documents are systematically stored. Either you can do it old school and have rooms filled with these documents or you can always opt for financial bookkeeping and accounting software.
- Have detailed accounting schedules that are easy to follow and regularly update them. It can be done by attaching schedules to your journal entries to have transparency and it usually makes it easier for auditors to trace every transition that has happened.
- When you start your business, create clear accounting policies and make sure to adhere to them consistently throughout the year. This uniformity in policy can actually reduce your workload and slashes discrepancy.
If you have followed the above steps then it is easier to handle Year end auditing.
Year End is here and it’s usually the last opportunity to make sure that all the financial records are accurate and complete before auditors arrive at your doorsteps. So, buckle up, because this stage is the most critical for catching and correcting issues that could otherwise delay the whole auditing process.
- Go back and start reassessing the accounting policies in light of any changes to your business or any new regulatory policies. Make sure your accounting policies remain practical and align with supporting documentation such as invoices, contracts and bills.
- Take those magnifying glasses and start going through each line item on your balance sheet to confirm that every amount is supported by relevant schedules or documents.
- Now that you are sure, share a draft of financial statements with your accounting team or executives for an additional layer of scrutiny. Tell them to be thorough with their review, crunch those numbers and flag any inconsistencies or areas that might need clarification.
Now that the audit has been completed, it’s time to reflect on the experience you had and use it as an opportunity to improve your financial processes.
- Before we get into the whole nitty gritty of it, take a moment to celebrate the smooth audit process. Pat on your shoulder and be proud of yourself and your team. Now, that’s over, identify areas where your processes worked really smoothly. Acknowledge these successes to build confidence and motivate your team.
- If it was not a perfect audit, discuss with your team what didn’t go well, Focus on the feedback you receive from auditors and internal observers. Sometimes this could have happened because of communication breakdown, delays in file sharing or inefficiencies in project management.
- While the imperfection might tempt you to address every issue out there, we urge you not to do that. Just focus on the implementation of one or max two changes that will have the greatest impact.
There you have it folks, we have given you all the preparation you need for auditing. Think of it this way though, audits are like routine checks ups of your business’s financial health. Whether it’s internal or external or even the Big folks from IRS, always remember the key to perfect audit lies in documentation, preparation and constant improvement. With this level of preparation, audit season will be just another Tuesday in your office. So take a deep breath, follow our instructions and continue developing your business.
