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Financial management

What is a business audit and why should you do one?

As a business owner, you juggle dozens of responsibilities. Sometimes, it feels like hundreds. Finding available resources—money and time—for a new expense is difficult.

However, every growing business must seriously consider investing the time and money required for an annual audit of the company financial statements. An audit performed by a CPA firm can help you work more efficiently, protect your company from employee theft, and will increase the accuracy of your accounting records.

This discussion defines an audit, explains the differences between types of audits, and reviews why this process is critically important for your business.

What is a business audit?

A business audit is a documented evaluation of whether or not a company’s financial statements are materially correct along with the standards, evidence, and assumptions used to conduct the audit.

The results are reported in a written audit opinion, and the language in the opinion defines an audit. An auditor reports on several topics:

  • Financial statements : An auditor reports whether or not the financial statements are free of material misstatement. In this context, the word “material” means an error or missing information that is large enough to impact the reader’s opinion of the financial statements. An audit is designed to identify financial statement errors.
  • Regulatory requirements : The financial statements must be prepared based on a set of accounting rules. For-profit businesses in the U.S. must use Generally Accepted Accounting Principles (GAAP), while governmental and not-for-profit firms use different sets of accounting rules. The audit opinion states that the financial statements were prepared in accordance with a specific set of rules.
  • Internal controls: Finally, most audits require an auditor to assess the effectiveness of internal controls . These controls are put in place so that the business can produce accurate financial statements, and prevent assets from theft. If there are weaknesses in any internal controls, the auditor must disclose the weaknesses.

Stakeholders—including investors, creditors, and regulators—rely on the accuracy of financial statements. An audit is performed to provide a higher level of financial assurance to stakeholders.

Differences between audits

It’s important to understand the difference between external and internal auditors because they each serve a different purpose.

A CPA firm performs an external audit, and the accounting firm must be independent of the business under audit. Independence means that the only compensation that the CPA firm receives is the fee for the audit, and the CPAs cannot perform tax, consulting, or any other work for the audit client.

An internal auditor, on the other hand, is a company employee, and these auditors are not independent. Internal auditors perform many of the same procedures that external auditors complete. In fact, a CPA firm may rely on some of the work performed by internal auditors.

Large companies have an internal audit department, but smaller companies do not. An external auditor may have to perform more work for a client that does not have an internal audit function.

An audit opinion from an external auditor is considered more reliable than work performed by an internal auditor because the CPA firm must be independent to issue an opinion.

Get a second opinion

An audit is an opportunity for a CPA firm to give you a second opinion on the accuracy of your financial statements. Auditors conduct work by reviewing assertions, and if there is evidence to support a particular assertion.

The existence assertion, for example, addresses whether or not the assets listed on the balance sheet actually exist. A company may be tempted to inflate the dollar amount of assets in the balance sheet, to make the business appear more valuable. Auditors use the existence assertion to address this risk.

As an fictional example, let’s say Julie Myers owns and operates Premier Homes, a home construction business. Her firm generated $1 million in sales last year, and the company is growing rapidly. Witnessing that growth, Premier’s tax accountant, Bob, recommends an annual business audit.

Premier Homes owns $150,000 in fixed assets, including machinery, equipment, and vehicles used for home construction. To prove the existence assertion, the auditor will physically inspect each of these fixed assets. Once an auditor gathers evidence to support each type of assertion, Julie will have third-party validation that her financial statements are materially correct.

Assess business efficiency

Rapid growth may cause an owner to lose control of operations, and business efficiency can decline. An audit reveals areas of company inefficiency and helps the owner to make improvements.

Auditors assess the income statement by reviewing changes in the expense and revenue balances over a period of years. Assume, for example, that labor costs have increased at a much faster rate than sales over the last three years.

Julie can use the income statement analysis and investigate the reason for the cost increase. She may find that new employees are not working efficiently and spending too much time on certain tasks. Julie then decides to increase her training efforts for new hires, so that she can reduce Premier’s total labor hours.

Reduce the risk of employee theft

The biggest risk for a rapidly growing company is employee theft, and an audit can help you identify areas of risk.

To manage growth, Julie has doubled the size of her staff in the last year, and she has quickly delegated work to keep up with the demands of the business. Without proper training and supervision, Julie may expose Premier to the risk of employee theft, particularly the theft of cash.

Every audit requires a careful review of the cash balance, including a recalculation of each month’s bank reconciliation for the past year. When the auditors arrive in February, Julie explains that she has not reconciled her bank account for December- the last month of her fiscal year.

Julie works with an auditor on the December bank reconciliation and finds a check payable to “cash”—and signed by Julie—for $12,000. After further investigation, the auditors determine that the administrative assistant had Julie sign the check and that the assistant cashed the check and kept the funds.

Based on this evidence, Julie contacts her attorney and terminates the employee before any further theft occurs.

Make the change

The demands of running your business can seem overwhelming, and it may be difficult to decide which tasks are most important.

Hiring a CPA firm to conduct an annual audit is a critically important step to take, in order to manage growth and make informed business decisions. Sure, an audit will require an investment of time and money, but the benefits of an audit far outweigh the costs.

Make this important change and hire a CPA firm to conduct an annual audit.

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