What is an Audit?

A financial audit is a process by which companies carefully review financial statements to obtain an accurate picture of their finances. Audits can be performed internally or by third parties, including the IRS. They often highlight discrepancies in accounting and provide detailed performance insights.

Companies use financial documents like cash flow reports, balance sheets and revenue statements to gauge their overall health. But how can they trust that the information in those reports is accurate? After all, companies need to show adherence to regulations and accounting standards.

An organization that hires internal stakeholders or external parties to examine the books is performing a financial audit. Financial audits are necessary to ensure accurate documentation of a business’s income and expenses. Thorough audits can provide confidence that a company is performing well and uncover areas of opportunity.

What is Auditing and Why is it Important?

Financial audits describe the review process of a business’s financial documents for accuracy. Most companies perform routine audits at least once per year.

Small business owners need to keep clear, accurate records of transactions. Disorganized records and incomplete accounting books create issues during an audit, leading to wasted time and energy.

Audits serve several purposes. Foremost, they help represent financial information to business stakeholders. Companies use audits to ensure financial statements meet relevant accounting standards, such as Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards .?

Because internal stakeholders prepare financial documents, there is always some risk of misrepresenting a company’s financial position. Auditing ensures that companies adhere to these standards and provide accurate and fair information.

How Auditing Works

Both publicly listed and private companies perform financial audits, although how and when those audits occur varies. Government agencies — including the Securities and Exchange Commission (SEC) — require public companies to conduct independent financial reporting audits. The SEC then uses those audits to validate annual financial reports.

Private companies do not face a legal obligation to audit their books. Most companies will still audit their records to provide information and confidence to the following groups:

• Investors
• Banks
• Stakeholders

Audits can take anywhere from a few months to a year. It depends on the number of accounts, transactions and verifiable data. At the end of the auditing period, auditors provide their findings regarding the financial reporting’s accuracy.

Auditing vs. Accounting

Auditing and accounting have some similarities but are not the same process. While they use the same bookkeeping standards and require many of the same skill sets, there are key differences :

• Accountants record financial transactions and produce statements. Auditors examine those documents for accuracy.
• Accounting is a day-to-day, ongoing process. Auditing occurs monthly, quarterly or once per year.
• Auditors do not need extensive math knowledge. Accountants do.
• Auditors often work for third parties. Accountants are also internal team members.
• Accounting requires attention to detail. Auditors need an investigative mindset.

What Do Auditors Do?

Auditors’ primary duties include inspecting accounting records and other documents to ensure accuracy and government and industry rule compliance. Auditors will often meet with managers or executors to share insights, especially regarding efficiency.

Most auditors — especially internal ones — work in an office setting, but some auditors work for third-party firms that travel to perform their work.

Types of Audits

Depending on the company’s status, it may experience three kinds of audits.

External Audits

An external audit involves the presence of a third party or external organization to perform the audit. These audits determine material misstatements, falsehoods or errors in a company’s financial statements.

These audits allow stakeholders to make decisions regarding the company undergoing the audit. Auditors who provide “clean” or unqualified opinions ensure accurate, complete financial paperwork for businesses and their stakeholders.

Since external auditors are independent, they can provide unbiased opinions. Several accounting firms complete external audits for corporations. The major accounting firms that organizations trust to perform these audits include the “Big Four” accounting firms of Ernst & Young, Deloitte, PwC and KPMG .

Internal Audits

Internal audits primarily involve employees of the company or organization. In most cases, auditors do not distribute their findings outside the organization. The results instead make their way into the hands of management and other stakeholders.

There are a few benefits of internal audits. For one, they can provide managers with actionable tools and feedback to improve decision-making and internal processes within an organization. Internal audits can also ensure compliance with applicable laws, industry and organizational standards, contractual commitments and trading regulations .

Internal Revenue Service (IRS) Audits

IRS audits review an organization’s accounts to ensure accurate reporting. The IRS will often randomly select corporations for an audit, or they may choose a company’s tax returns for auditing due to related examinations of business partners. The primary purpose of an IRS audit is to verify the accurate reporting of taxes.

The IRS will typically look through the documentation for the previous three years, although that period can sometimes extend to six years. Likewise, the IRS audit may take longer depending on the issue's complexity and whether the organization agrees with the findings.

What is an Audit of Financial Statements?

An audit of financial statements is the systematic review of a company’s cash flow statement (CFS), income statement, balance sheet and statement of shareholder equity.

• Cash flow statement: These documents are vital to showing investors and stakeholders that a business is financially stable enough to pay debts, afford operating expenses and fund investments. Auditors check these statements by verifying the accuracy of footnotes and cash flow entry values.
• Income statement: Showcases a company’s performance over the fiscal quarter or year, such as incurred expenses and generated revenue. Net profit and net loss will also be included in the last line of the report. Auditors will verify income statements by looking over the company cash book plus books of accounts.?
• Balance sheet: Reports a company’s financial position for a specific period (e.g., a fiscal quarter). Assets and liabilities will be documented in order of liquidity, or how easily they can be converted to cash . Auditors assess balance sheets by checking assets and liabilities for accuracy.
• Statement of shareholder equity: Allows shareholders to determine a company’s value and evaluate significant changes that occur over a fiscal period. Companies may either include this document as an individual statement or add it to a balance sheet.?

Steps for a Successful Financial Audit

An audit’s success or failure comes down to preparation . Before a company faces an audit, it must put its financial documents in order. IIn an ideal situation, organizations have easy access to essential documents such as:

• Bank statements.
• Credit card statements.
• Receipts.
• Invoices.
• Journal entries.

Designate a Point Person

Having too many people involved in an audit — and the communications surrounding it — can breed confusion. Instead, designate a single person to handle contact between the company and its auditors. This person is the chief point of contact for the audit firm.

Their role in the audit is to direct any questions to the appropriate personnel. They will also delegate needs to internal teams and ensure those concerns are met.

Schedule the Audit for a Slow Period

Audits can impact a company’s regular operations, so scheduling them during slower periods can reduce stress on everyone involved. Even though audits may take weeks, months or even an entire year, beginning the process during a slow period can minimize disruption.

Ensure Information Is Available

Ensuring as much information as possible is available before and during the audit can help the process go smoothly. When auditors must search for details such as credit card statements or other documentation to verify expenses, it can create a backlog.?

As part of the preparation, companies should pull as much information as possible. Remember: some audits require up to six years of financial information.

Identify Changes in Business Expenses

One of the biggest small business audit triggers is a sudden change in business expenses. Excessive spending from one year to the next could trigger an IRS audit . Sudden shifts in expenses could be a sign of financial mismanagement or falsified information.

Look for Opportunities to Cut Costs

As part of the auditing process, it is worth considering opportunities to cut costs . Because an audit serves as a “deep dive” into a company’s books, an outside perspective can help. Assess current contracts and determine where savings can be found.

Study Business Credit Cards & Transactions

As part of an internal audit, sifting through business credit card statements and transactions can highlight inaccuracies or even improper usage of company funds. Anyone who uses a company card should be able to file an expense report or document the usage of that payment method for business purposes.?

Verify Business Loans

Another component of a successful internal audit is the verification of business loans . Were these loans used for business purposes or approved items? How did the company spend that money?

Compare Results with Financial Objectives

Once an audit is complete, compare the results with a company’s financial objectives or forecasts . How much of a discrepancy is there between the two? If a company spends more than its previous budgets, it could signify future trouble or financial mismanagement.

Final Thoughts on Auditing

Financial audits are not a strict requirement for all businesses, but they are essential for reconciling financial data. Regular audits can ensure adherence to accounting best practices. They also provide detailed information to stakeholders that can inspire confidence in a company’s current operations and business plan.

Top Takeaways

• Financial audits are a standard tool for publicly listed and private companies.
• Many private companies perform internal audits to ensure the accuracy of accounting.
• Publicly listed companies must file audits to meet regulatory guidelines.
• The IRS can audit companies to ensure compliance with tax laws.
• Successful audits take careful planning and attention to detail, including the availability of records.

(Reporting by NPD)