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Financial Audits and When You Need One

The word “audit” conjures images of the IRS and federal agents combing financial documents. But financial audits are actually beneficial to companies and are often required in certain circumstances. To understand why, it is first important to understand what an audit is.

An audit is a formal inspection by a certified public accountant, who is independent of the company being examined, of their entire financial situation. An audit may include; a thorough analysis of a business’s books, financial statements, and records; an examination of the internal controls in place; test transactions to verify accuracy contained in financial statements; and briefings with management to discuss risks, weaknesses, or other issues uncovered during the audit.

It is also important to understand the different types of audits that might be conducted:

  • Financial audit–This is the most common type of audit and involves ensuring that sound accounting principles are instituted within a business and that financial statements are accurate.

  • Performance Audit–This audit is used to improve the accounting practices within a company with an aim to inform management and to improve efficiency and effectiveness.

  • Internal Audit–This type of audit aims to identify and control risk factors within a company.

  • Forensic audit–Forensic audits are performed for legal proceedings that will appear before the court.

Whatever type of audit is performed, the accountant or firm will begin by studying competitors and the industry of which the business is a part. They will then test control processes such as employee authorizations and asset protections to probe for weaknesses. Finally, they will thoroughly examine all financial documents, such as statements of shareholder equity, balance sheets, and income and cash flow statements.

Once and audit is completed, the accountant or firm will issue an opinion, which may be one of the following:

  • Unmodified opinion–The company follows acceptable bookkeeping standards and all financial statements are accurate.

  • Qualified opinion–The company demonstrates small areas of weakness that can be addressed based on the audit report and resubmitted for an unmodified rating.

  • Adverse opinion–The audit reveals significant weaknesses and gaps in processes and records that suggest information in financial statements is not trustworthy.

  • Disclaimer of opinion–Essentially a lack of opinion because the auditor has not been provided sufficient access or information to be able to complete the process.

Now that you understand the basic process of audits, you may be wondering if you have to or should have one conducted. This depends in part on your company. Audits are sometimes required by lenders, insurance companies, or regulatory agencies. You may also find that depending on the industry you're in, standards may require an audit. You will also need an audit if your business reaches $2 million plus in revenue, your planning on selling, or if you want to go public (federal regulations require that all publicly traded companies undergo annual audits).

There are also benefits to being audited that lead companies to do so even when not required. It can, for example, help management estimate risk, better understand control systems, and improve procedures to address weaknesses. Furthermore, audited statements create higher credibility for the company and increase user confidence. Finally, audited systems increase dependable accounting practices among employees.

These are just some of the benefits of auditing your business, but you will ultimately have to decide if auditing is worth the investment. Understand that a small-sized business whose structure isn’t particularly complex will pay around $20,000 for an audit. You may, therefore, want to assess factors such as the size of your business, complexity of its structure (e.g., multiple locations, inventory size and storage locations), whether you conduct domestic or international business, and the number of transactions a year before you decide on investing in an audit.

Written by Ivan Young in partnership with steel piping distributors, Fed Steel.


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