What You Need To Know About Audited Financial Statements
September 30, 2022 •ROARK
Lenders may ask to see your financial statements when you need a business loan. These statements are created by accountants and include four basic statements:
- Profit & Loss
- Balance Sheet
- Statement of Cash Flows
- Statement of Changes in Owner’s Equity
However, if the lender still feels uncertain about your finances, they may request an audited financial statement. Let’s look at how audited financial statements work and the steps auditors take to review and analyze your business financials.
What Are Audited Financial Statements?
An independent auditor examines audited financial statements. This auditor issues a report indicating if financial statements are free from material misstatement. A material misstatement is any information found in financial statements that may impact the economic decisions made by a business. Accurate financial statements are crucial when looking for funding.
Who Needs Audited Financial Statements?
Several entities may require audited financial statements, for example, banks, investors, and government agencies. In some instances, these statements are required by law, primarily for publicly traded companies looking for investor funding.
Types Of Audited Statements
We described the four main statements created for the audit process, but additional statements may be used to provide a fair representation of the company’s performance and condition. But first, let’s take a look at the three stages of the auditing process.
- Internal Control Testing
The auditor analyzes the internal control procedures and confirms they are effective. The focus is on employee authorizations, protection, preservation of assets, and separation of duties. These procedures are tested to determine their strength. If auditors find them effective, they may move to more intense auditing procedures. However, if ineffective procedures are found, additional financial examinations are performed.
- Planning & Risk Evaluation
Auditors must understand the business and competitive environment where it operates. The auditor uses industry knowledge and determines if specific risks could affect the validity of financial statements.
- Substantive Procedures
Auditors use various investigative procedures to verify the validity and accuracy of the company’s financial data. Fully audited statements are evaluated under intense scrutiny to ensure the accuracy and correctness of the financial statements. A complete audit procedure includes the following financial statements.
- Cash – The auditor sends confirmations to banks and confirms balances. They review past reconciliations and authorized signatures and count any cash on hand.
- Accounts Receivable – Letters are sent to customers confirming outstanding balances. In addition, collection procedures to track cash flow and checks are analyzed. The auditor also tests annual sales figures and cutoff procedures.
- Inventory – The auditor observes the inventory's physical count and inspects paid vendor invoices. They then review the costs of production and the allocated overhead calculations. Lastly, they track inventory cost postings to the general ledger.
- Marketable Securities – The existence of securities and the latest value are verified, and these transactions are reviewed.
- Fixed Assets – Assets are physically inspected, and purchase authorizations and vendor invoices are reviewed. Lease contracts are also reviewed during this process.
- Accounts Payable – Balances owed to vendors are validated, and year-end cutoff procedures are analyzed.
- Accrued Expenses – Expense postings, payments, and accrual methods are compared with year-to-year balances for consistency.
- Debt – Confirming debts to lenders are sent, and payment terms of lease agreements are checked.
- Revenues – Sales invoices and postings to the general ledger are checked. The authenticity of customer sales is validated, and the cash flow of collections is reviewed. The auditor also analyzes the return, discount, and allowance history.
- Expenses – Purchase documents for business expenses are examined, and payments are verified and sent to the correct parties. In addition, a deep dive looking for unusual items is performed.
Getting Ready For The Audit
Getting ready for an audit is crucial to a smooth audit process and a correct audited financial statement. Reviewing the process and steps ahead of time minimizes interruptions to day-to-day financial operations and helps ease office staff concerns about having everything ready and properly organized when the auditor asks for them. Below is a list of steps to prepare for the audit and help teams prepare for the work.
- Reconcile significant accounts like cash, accounts receivable, inventory, accounts payable, and accrued expenses. This step is critical to prepare for your audit. Adjustments discovered during audit fieldwork often relate to reconciliations not being prepared.
- Reconcile any changes in equity accounts, including new equity agreements or amendments to existing ones. This reconciliation ensures that any changes in the equity accounts are appropriately accounted for and presented accordingly.
- Collect new agreements or amendments to existing contracts during the fiscal year. These include operating agreements, lease agreements, debt agreements, etc. Your auditor will review these agreements, which are used to prepare footnotes on your financial statements.
- Update PP&E schedules and compile a list of assets you’ve purchased or sold over the year to expedite the auditing process. Be sure the PP&E summary includes dates, amounts, and descriptions of assets you’ve bought and sold.
- Confirm that your capitalization policy complies with IRS regulations.
- Gather and compile detailed records of transactions, including sales, purchases, leases, etc. These transactions are reviewed during the audit and used to prepare footnotes in your financial statements.
- Identify and communicate all significant business operations or accounting methodology changes from the previous year (if applicable). Proactively addressing these changes ahead of time ensures the audit goes smoothly. Be upfront with your auditor about any significant transactions (purchases, debts, leases, etc. and proactively work through a transaction after it occurs to allow monthly reporting to be correct.
- Look over the auditors' preparation checklist and prepare all items listed before the audit begins. We’ve created a general list of things most frequently needed for small- to medium-sized businesses. This information should be submitted electronically, and depending on your industry, additional items may be requested depending on your industry.
Audit Preparation Checklist
- A General Ledger covering the entire fiscal year
- Internal financial statements
- Organizational documentation like articles of incorporation or bylaws
- Equity certificates
- Employee handbook
- Policy and procedures manuals for accounting
- Org charts and systems documentation - these can be memos detailing the flow of transactions within your company.
- Bank notes, security agreements, and lease agreements
- Meeting minutes from oversight committees or the Board of Directors
- The budget for the fiscal year being audited
- All paid bills and checks received
- All asset, liability, and equity account reconciliation and supporting schedules
It can be a stressful process to go through a financial statement audit. However, the process is relatively painless for everyone involved, with the right amount of preparation and communication. Being prepared for the audit saves you time and money in the long run.
The Benefits Of A Financial Statement Audit
When most people think of the word audit, they get nervous and worried about the outcome. But, a financial statement audit isn’t an enemy. On the contrary, it’s a good thing.
You get an overview of financial records and standing
One of the most obvious benefits is the overview of your financial records it provides. The audit process offers the opportunity to review financial statements, identify problem areas, and correct them.
Finding areas for improvement
Once you’ve discovered problem areas, you can target them for improvement. An audit clearly demonstrates any gaps in your financials and inefficiencies to address. Whether operational, procedural or from an accounting perspective, an audit provides critical information about your internal controls and if they’re effective.
Opportunity for conversation
Yes, it seems odd, but an audit provides an opportunity to start a conversation about profit and loss. So often, most businesses don’t discuss profits and losses as frequently as they should, but finding clarity around line items reflecting losses can open a conversation to improve profitability.
You can’t fix something that you don’t know is broken. An audit highlights the problem areas and is an excellent risk management tool. Understanding how your procedures around cash receipts, disbursements, and payroll are managed helps you evaluate and find new ways to decrease the risk of fraud before it becomes a severe problem.
Provides a safety blanket
Even if you’re not required to have an audit, it’s a great idea to do one. It helps you to be proactive about any issues and provides transparency to your lenders and investors. In addition, this reassurance helps increase credibility and display stability when looking for funding.
Always Be Prepared
One of the best ways to prepare for a financial statement audit is to outsource your accounting. Hiring a professional firm to keep track of your finances is a big help, especially if you don’t have an in-house accounting person or team.
With an outsourced accounting firm, your financial records are up to date and accurate with all the right processes and controls in place. In addition, a firm has the necessary resources and technology to perform accurate and timely reporting and prepare everything for an audit. This gives you one less thing to worry about, and you can focus on other business-related operations.
ROARK - Finance & Accounting as a Service
ROARK has the infrastructure to get the insights and reporting you need to grow your company. We put the right processes, internal controls, best practices, and technologies to make the audit process painless. With ROARK, you get a dedicated individual or team to manage all or part of your financial processes and ensure that you have the information on hand to make informed business decisions. For example, suppose you want to improve your finance and accounting operations and be ready for a financial statement audit. In that case, ROARK has the technology and people to help you navigate the process easily. Contact us today if you’re ready to outsource your accounting and financial operations.