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Updated December 2023


As a business leader at a growing company, a financial statement audit probably isn't top-of-mind right now. After all, you also have to grow revenue, manage day-to-day operations, and navigate a pretty volatile marketplace.

But your moment in the audit sun will come at some point, and when it does, you have to be prepared. That is, assuming you want to seek outside capital or even sell your business someday. Still, the idea of an external party digging through your books can be daunting to say the least, especially if it's your first audit.

Thankfully, as we’re about to discuss, audits don't have to be as painful or overwhelming as some might think. So let's dig into why your company might need a financial statement audit, what to know about the process, and how you can best prepare for it.

What Is a Financial Statement Audit?

A financial statement audit is an examination of the many factors, data points, and processes informing your company's financial reporting – balance sheet, income statement, cash flow statement, footnotes, and disclosures – by a third-party, independent auditor.

That's not to say, however, that your assets, liabilities, and liquidity are the stars of the show. Instead, the external auditor – audit team for larger companies – examines what’s driving these critical areas, reviewing your company's internal controls and processes, and reporting on their findings.

Audit procedures might vary based on your company's industry and accounting practices. But in general, the auditor will do a high-level examination and risk assessment of your finances and operations, then look at specific transactions and underlying data as they deem necessary. In some instances, they'll focus on areas more prone to error or fraud, but many times, it's simply spot-checking records.

FREE RESOURCE: The Definitive Guide to Financial Audit Preparation
Once the examination is complete, the auditor will generate a comprehensive report and final audit opinion, speaking to whether your company's financial reporting consists of accurate financial information and complies with Generally Accepted Accounting Principles (GAAP). Financial audit reports generally fall into one of four categories:

  • Clean report: There’s no problem with the audited financial statements and the auditor believes the company is in full compliance with GAAP.
  • Qualified report: When a company isn't fully compliant with GAAP, the auditor will give a qualified opinion and list areas needing improvement.
  • Disclaimer report: If a business is unable or unwilling to grant the auditor full access to data or sufficiently answer questions, the auditor will speak to the situation rather than providing an assessment of their financials.
  • Adverse report: The auditor found gross irregularities in the company's finances, and the company does not comply with GAAP. It goes without saying that an adverse opinion is bad news.

Key Stages of a Financial Statement Audit

A financial statement audit can seem like a daunting journey. However, understanding its stages can pull the curtain back from the process and prepare you for the road ahead. So, on that note, let’s walk through the typical stages of a financial statement audit.

Stage 1: Planning and Risk Assessment

Planning and Risk Assessment is the foundation of an effective audit. During this initial phase, auditors gain an understanding of your business and industry, assess the risks of material misstatement in your financial statements, and determine the scope of the audit.

This stage involves setting the audit’s objectives, timing, and resource allocation. It’s also when the auditors evaluate your company's internal controls, identifying areas that might require more attention.

Stage 2: Internal Controls Testing

In the Internal Controls Testing stage, auditors closely examine the processes and systems you use to prepare your financial statements. This step is crucial in assessing the reliability of your internal control mechanisms to prevent or detect errors and fraud.

Additionally, auditors look at various controls, including how you authorize, record, and report transactions. A robust internal control system can reduce the extent of the substantive testing needed in the next stage.

Stage 3: Substantive Testing

Substantive Testing is where auditors roll up their sleeves to verify the details of your financial statements. They examine key financial transactions, balances, and disclosures through various methods like physical verification, confirmation with third parties, and analytical procedures. This stage is all about gathering sufficient, appropriate evidence to support the information presented in your financial statements.

Stage 4: Reporting and Audit Opinion

Finally, the Reporting and Audit Opinion stage concludes the audit. Here, auditors compile their findings and express an opinion on whether your financial statements present a true and fair view of your financial position, one that conforms with accounting standards.

Once again, the outcome is typically one of the following types of opinions: unqualified (clean), qualified, adverse, or disclaimer. This report is crucial for stakeholders relying on the accuracy of your financial information.

Embracing the Audit Journey

Obviously, each stage of a financial statement audit plays a vital role in building a comprehensive view of your company’s financial health. While the process can be intricate, understanding each stage helps you better prepare and collaborate with your auditors, ultimately leading to a more efficient and effective audit.

Remember, a well-conducted audit not only meets compliance requirements but also provides valuable insights for your business, enhancing trust among investors, regulators, and other stakeholders. And those are all very good things.

Situations Requiring a Financial Statement Audit

Moving on to our more practical insights, small and medium-sized businesses can go years without needing to audit their financial statements. However, two common situations lend themselves to financial statement audits.

Seeking Outside Funding

External funding has always been critical for companies to facilitate growth. Whether you're looking to take on debt via a loan or courting investment from PE or VC firms, you'll need to provide audited financial statements. In most cases, the funding source will define specific terms for the audit, such as the timeline for completion.

Strategizing for the Future

Even without an urgent need for funding, performing an audit is the first step in laying the groundwork for the future, including a significant business expansion, an IPO, or virtually any other exit strategy. Whatever the reason, getting your financial reporting ducks in a row will help determine your options for future transactions.

Understanding the Advantages of a Financial Statement Audit

For most businesses, a first-time financial statement audit stems from an external need. However, the results are often useful beyond the immediate purpose of the audit. Depending on the results, there are a handful of common benefits to the audit process:

  • Confidence in financial reporting: Providing reasonable assurance over the accuracy and integrity of your finances allows stakeholders to make informed economic decisions without worrying about material misstatements, intentional or by error.
  • Better access to capital: A good business model and solid revenue are the first steps to securing loans or investments. But proving robust accounting controls and a healthy financial position will give lenders or investors more confidence to provide favorable terms to your company.
  • Improvements in accounting controls: Although discovering your internal accounting controls aren’t up to snuff isn’t exactly fun, it provides a roadmap to fixing the issues. With better internal controls in place, your company will be stronger and more resilient.
  • Business process optimization: Similarly, audits can help reveal gaps in your internal processes. While the auditor's report will identify some of these, the preparation phase is often even more illuminating. As your team documents everything, digs through records, and pulls data together, any delays and friction points they encounter likely represent business processes you can improve.

Fraud detection: The Association of Certified Fraud Examiners estimates that the global cost of occupational fraud exceeds $3.6 billion per year. While you hope your company won't be part of that statistic, an audit can help reveal financial fraud that might have slipped through your company's internal controls.

Considering the Drawbacks to a Financial Statement Audit

Financial statement audits are generally positive for a business. They either indicate that you're doing things right or provide clear indications for corrective measures. Still, there are a few downsides to keep in mind:

  • Limited scope: While audit reports may confirm a company's accounting practices are sound, it would be impossible for an auditor to examine every transaction or financial record. Thus, errors can still slip through the cracks.
  • Cost: Financial statement audits can cost $20,000 or more for small companies, depending on the specifics. Even worse, the price can run into six or seven figures for larger companies. While it's an important step, businesses need to weigh the cost against the potential benefit of the audit.
  • Time investment: Financial audits involve significant labor costs. Your company's primary point of contact for the auditor will essentially have a new full-time job for a few months. And other parts of your accounting team will need to provide support with research and data collation throughout the process.

Choosing the Right Auditing Firm: Key Factors to Consider

Big companies have limited options when selecting an auditing firm, as the Big 4 handles 88% of audits for large public companies in the U.S. However, small businesses have a wider variety of options, including full-service accounting firms and certified public accountants (CPAs).

Before selecting an auditing firm, we recommend asking these key questions:

  • How much experience does the firm have working with similarly sized companies in your industry?
  • What kind of reputation does the firm have? Have they faced any regulatory reviews recently?
  • Do they stand out from competitors in any way?
  • How much time and attention can they provide your company?
  • If your company spans multiple jurisdictions, can the firm effectively interface with counterparts elsewhere?
  • What is their plan for resolving disagreements about accounting policies and procedures that might arise during the audit?
  • How will they keep your company's management and board of directors apprised of changes in accounting standards?
  • Does the firm have any potential conflicts of interest that would prevent them from maintaining independence and objectivity?
  • What are the billing rates for each class of personnel you'll be working with?

Avoiding Common Mistakes in First-Time Financial Audits

As with most complex procedures, the financial audit process has the potential for miscues, mistakes, and oversights, including:

  • Poor documentation & record keeping: Any significant lack of documentation or record-keeping can lead to problems during an audit. Even if your company's financial statements are correct, you must have the supporting data to prove it.
  • Unclear segregation of responsibilities: Employees may fulfill multiple roles in startups and smaller, lean and mean companies. While this makes sense operationally, it often leads to lax internal controls. In this case, an auditor will likely want to perform more substantive testing to examine supporting documentation.
  • Accounting delays: During an audit, your accounting team must balance ongoing accounting tasks with providing information to the auditor. Understaffed or unprepared teams can lead to delays in normal accounting functions as well as the audit process itself.

Streamlining Financial Statement Audit Preparation

An audit of financial statements is a complex and costly process. However, proper preparation helps minimize the burden on your company and employees. Address the following areas early on to ensure a smooth financial audit.

Plan for Organizational Commitment

Management needs to prioritize the audit across all relevant departments. To balance normal operations with keeping the audit process moving efficiently, designate a team member to act as the primary point of contact for the auditor. This person should be on the project full-time and route all requests to the correct internal contacts.

Gather Accounting Records

Before the audit begins, ensure you have all your financial records and audit evidence ready, including bank statements, account reconciliations, and a clean general ledger, amongst others. If you need information from other companies, such as clients' accounts receivable data, get those ready as soon as possible. You don't want to be scrambling for information once the auditor is already on the clock.

Understand the Financial Audit Process

Having someone on your team at least familiar with auditing standards and processes is critical. Auditors aren't working against you – they're inherently neutral – but navigating the process for the first time can be challenging. Doing so without experience can lead to extra expenses, frustration, and a poor audit report.

Shore Up Your Accounting Processes

The auditor won't just examine your records; they'll also be looking at your accounting processes. Therefore, document your systems and controls as thoroughly as possible. This step can also reveal shortcomings in your GAAP compliance, reducing potential surprises during the audit process.

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Develop a System for Data Sharing

You'll provide the auditor with a massive amount of information throughout the financial audit process. All told, you'll be sharing accounting records, contracts, vendor agreements, corporate documents, and more. Before the audit begins, set up a shared drive and determine a structure to help keep information organized and easily accessible.

Consider Using an External Advisor

If you’re new to financial statement audits, you probably don’t have an internal audit role or audit committee yet. And even if you do, partnering with an external accounting advisor can still be extremely beneficial. They know the right questions to ask the auditor and can also assist in providing answers. They can also act on your company's behalf and with your interests in mind which, needless to say, can feel like manna from heaven in certain situations.

Remember, as thorough as we’ve been here, we’ve still just scratched the surface, leaving a boat-load of confusing, scary-sounding acronyms for another discussion, including: the Public Company Accounting Oversight Board (PCAOB), the International Financial Reporting Standards (IFRS), and Generally Accepted Auditing Standards (GAAS). Not to mention the lovely people at the Securities and Exchange Commission (SEC) and the American Institute of Certified Public Accountants (AICPA). Downright daunting.

The point is, these tips and considerations are the jumping-off point, not the end-all-be-all. They should serve as a basic financial audit checklist to help you prepare, building a footing that specialists can work from to help you prosper through an audit. And, not coincidentally, is where Embark fits into the mix.

Our team has helped guide companies of all shapes in sizes through even the trickiest and complex audits. So if you're facing your first financial statement audit and starting to sweat the details, we’re just a short contact form away.

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