Opening a business comes with an endless to-do list. Chief among them is raising capital, whose importance is hard to overstate.
But to attain funding, your startup will require a financial audit first. Having comfort that your financial statements have been audited builds trust with venture capitalists and other types of investors.
Given the stakes of a financial audit, you’ll want to give your startup the best chance of receiving funding. Here’s what you need to know so you can prepare accordingly.
What is an audit?
In a financial audit, an independent third-party auditor examines the financial statements and internal controls of your business. The auditor is expected to express an unbiased opinion on the presentation of your financials.
But the auditor cannot proceed alone. Entrepreneurs and members of management should be ready to play a key role in the process.
You’ll be required to prepare the financial statements that the auditor will review. But you can be ready for this by setting up effective internal control and accounting function processes from the start.
Other than providing the required financial statements, your role will be minimal. In general, your company’s board of directors is expected to communicate directly with the auditor, serving as an intermediary between management and the third party.
Why is an audit of financial statements necessary?
It’s no secret that startups are expected to demonstrate financial health from the beginning. But some entrepreneurs may overstate or understate certain accounts to paint a rosier picture.
The financial statement audit aims to assure outside parties, like lenders and investors, that there are no such material misstatements or instances of fraud in your business’ financials. It also shows your board of directors that the business’s financials are accurate and meeting expectations.
What are the different types of financial audits?
There are two main types of financial audits: internal and external.
An external audit is conducted by an independent third party, like an accounting firm. The objective is to confirm the validity of your financial statements.
In an external audit, the auditing and accounting standards are followed as required by state and national agencies. This allows the auditor to express an informed professional opinion on the overall presentation of financials.
An internal audit is performed by your company’s employees or management. These reports are often pulled directly from accounting software to confirm controls are working properly and to check whether misstatements exist.
The goal of an internal audit is to give management and employees feedback on their internal controls. Regular internal audits also prepare your company’s accounting team for an external audit.
Do I need a financial audit checklist?
External auditors will request four startup financial statements:
- Balance sheet.
- Income statement.
- Statement of owner’s equity.
- Statement of cash flow.
Each of these statements gives a different insight into your business’s operations and financial health. Forgetting to include one can lead to an unclean opinion.
To get around this, create a financial audit checklist to ensure you and your management team remit the proper information to external auditors. A checklist will also help management track document requests throughout the audit process.
While it may take a few hours to piece together this checklist, your efforts will contribute to a smoother outcome.
What is the typical financial audit process?
The financial audit process involves multiple steps that can be broken down into these broad categories:
Step #1: Planning and risk assessment
The first step in any audit is to plan for the upcoming processes and timeline. Deciding when the work will begin, the fee for service and any other important items need to be worked out in advance between the auditor and the board of directors.
The auditing firm will then make preliminary assessments of risk levels and ask questions to understand business operations.
Step #2: Testing internal controls
The next step is conducted by the audit firm with help from management and the board of directors. The independent auditors evaluate the internal controls to make sure they are operating correctly, and that they are preventing fraud and misstatements.
Inquiries of employees and a walkthrough of procedures aren’t uncommon in this step. It’s important to be ready for whatever the auditor requests.
Step #3: Substantive testing of the financial statements
Substantive testing in the audit involves evaluating the financial statements for misstatements. Common audit procedures found here include analyses of balance sheet items, ratio testing of the income statement and following up on any concerning accounts.
Auditors have an extended scope in their abilities. That means they can contact your customers, vendors, lenders and investors for information pertaining to your financial statements.
Step #4: Issuing an opinion
The last step in an external audit is when the third party issues an opinion on the overall presentation of your financial statements and the functionality of internal controls.
An unqualified opinion from the auditor means that no major issues were found. A qualified, disclaimer or adverse opinion indicates the auditor found issues and can raise flags for investors.
To reiterate, you want to ensure accuracy throughout your accounting function to give your startup the best chance of receiving a clean opinion.
Is a financial audit the same as a review?
Financial statement audits and reviews have some similarities. Both look to evaluate the financial statements for misstatements and require an independent third party to sign off on the report.
But a review is less comprehensive in scope than an audit. A review entails fewer tests, and an opinion is not expressed.
As a result, reviews are often more cost-effective for startups. The need for an audit or review depends on what investors are requesting.
Knowing what to expect from a financial audit is critical whether you’re seeking additional venture capital funds or a first round of capital. Investors want assurance that your business is properly reporting its financial position. A financial audit can also identify areas of improvement to maximize the long-term success of your startup.