February 19, 2013 | 4 minutes read( 730words)
Often I work with business owners who think their company is in need of a traditional audit. My first question for them is always...why?
In some cases, the high level of assurance of an audit is required and no other substitute will do. Third parties, like investors and lenders, may insist on assurance that the financial statements they are basing their decisions on accurately represent the state of your financial condition. In particular, they may want to know that:
But many times, third-party financial statement users may request an audit when it is not really necessary.
- Your accounts receivable will be collected in full
- Revenue reporting accounts for all sales within a given accounting period
- Your reported cash flow accounts for all money received from business operations
Often, you don’t really need a full audit to provide the necessary assurance of the reliability of your financial statements. Depending on your organization and who has requested your financial statements, you may be able to go with a different level of assurance.
Before going down the complex and costly road of a traditional audit, you should be aware of some of these other levels of assurance for your financial statements that a CPA can provide, including:
- Compilation - Management financial information presented in a standard format, but the balances are not verified by an independent third party.
- “Agreed-upon procedures” - A review that is focused on just one aspect of your financial records. A report is provided, presenting the necessary information, but no assurance is provided.
- Review - CPA takes management financial information and analyzes the numbers to some degree, looking for an internal financial logic. Similar to an audit, but with limited assurance.
- Audit - Confirms all financial information and tests internal controls. This is the highest level of CPA assurance.
We suggest that our clients push out an audit as long as possible, because of the monetary and time cost—and plain old hassle. With the costs of audits increasing, these other assurance options can be much more appealing than a traditional audit.
That being said, if you find yourself in any of the following situations, you will typically need to have an audit:
- When it is required by an equity investor. Sometimes—typically after a Series B or a Series C—an investor will require that you have an audit. In these cases, a lower level review won’t suffice. Pre-revenue, you may still be able to negotiate around a full audit, even if it is requested. As your company matures, however, an audit will likely be required.
- When it is required by a lender. If you’re reaching out to a lender for venture debt, an AR line of credit, or other types of bank loans.
- When you’re company is “trading hands.” If you think you are going to try to sell your company or it is going to be acquired.
- Pre-IPO. If you’re taking your company from a private company to a public one, preparing to sell shares of stock to the general public.
If an audit has been requested, it’s still worth having a conversation with the third-party financial statement user to confirm what level of assurance they are looking for and whether a lower level assurance will suffice.
Even if you don’t need an audit quite yet, it makes good business sense to keep solid financial records. You want to make sure you’re documenting your processes and controls for all of your financial transactions—even those that don’t directly affect your cash balance. This will help you to run your business more effectively and will set you up for success if and when you do find yourself in need of an audit.
Do you think your business needs an audit? If you have questions about audits, please let us know in comments below, or contact Early Growth Financial Services.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial and accounting services to companies at every stage of the development process. He's a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.