Posted by Early Growth
February 19, 2013 | 4-minute read (720 words)
Does my startup need an audit? As an entrepreneur, you’ve no doubt asked yourself this question. And you’re not alone.
Often I work with startups 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 and security of a startup audit is required and no other substitute will do. Third parties, like investors and lenders, may insist on assurance that the financial data they are basing their decisions on accurately represent the state of your financial condition. In particular, they may want to know that:
- 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
But based on experience, third-party financial statement users may request an audit when it is not necessary. Often, you don’t really need a full audit to provide the necessary assurance of the reliability of your key financial statements. Depending on your organization, financial model, 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 auditing a startup , you should be aware of some of these other levels of assurance for your financial statements that a startup CPA can provide, including:
- Compilation -A list of 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 startup audit services 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 a startup 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 startup audit, even if it is requested. As your company matures, however, an auditing service 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 your company is “trading hands.” If you think you are going to try to sell your company or it is going to be acquired in the future.
- Pre-IPO. If you’re taking your company from a private company to a public one, prepare 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 check what level of assurance they are looking for and whether a lower level assurance will suffice.
Even if you don’t need an auditor quite yet, it makes good business sense to keep solid financial records, potentially looking for outside startup accounting services. 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 a startup auditor.
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.