As businesses are formed and as they grow, one question often asked by owners and chief financial officers is whether their companies would benefit from an audit. As you might have guessed, the answer depends on a number of factors specific to each company. Below is helpful information about audits to keep in mind as you decide whether or not an audit is right for your business.
Audit vs. Compilation vs. Review
Although audits, reviews, and compilations all involve a report on financial statements, an audit provides a higher level of assurance compared to a review or a compilation. Here’s what each consists of:
The most basic of the three, a compilation is when the accountant assists management in presenting financial information in the form of financial statements without providing any assurance that there are no material modifications needed to the financial statements.
In a review engagement, the accountant performs analytical, inquiry, and other procedures to obtain limited assurance that no material modifications should be made to the financial statements.
An auditor obtains reasonable assurance about whether the financial statements are free of material misstatements. In order to obtain this assurance, auditors are required to gain an understanding of an entity’s internal controls and fraud risk. During the audit, tests of balances and transactions through third-party confirmations, physical inspections, observations, and other procedures are performed. Due to its greater scope, an audit is higher in cost, but the benefit is that it is more thorough and provides a higher assurance of accuracy.
Should I Consider an Audit?
There are many reasons why a business may benefit from an audit. Here are a few examples:
- Greater access to credit and more favorable borrowing terms. Because of the comparatively high assurance that comes with an audit, banks and other lenders are generally more likely to extend higher levels of credit to businesses with audited financial statements. Additionally, loans to audited companies may come with better terms, such as lower interest rates or the elimination of personal guarantees.
- Required by lenders, regulators, bonding companies, or other parties. In some cases, an audit may be required for a company to obtain credit from a lender or vendor, or to receive bonding. Customers may also request audited financial statements to evaluate the business’s ability to fulfill large orders or complete contracts. Businesses operating in certain industries may also be required to provide audited financial statements to federal or state regulators, and audits will likely be required for companies performing contracts for federal or state entities.
- Required by partnership or shareholder agreement. In some cases, a partnership or shareholder agreement may require a business to obtain an annual audit. Other agreements, such as a buy-sell arrangement, may also require one.
- You are considering selling the company (or may be in the future). Having a history of audited financial statements can make a company more attractive to investors or other businesses that may be interested in purchasing the business. This can lead to a smoother transaction and possibly a higher selling price.
- To promote accountability within the business. In addition to the value an audit can provide in dealing with outside parties, an audit can also encourage accountability and best practices internally.
Internal Benefits of Audits
As auditors gain an understanding of internal controls, they are required to communicate any weaknesses they identify to the company board and management. These auditor communications can be a valuable resource in helping management and ownership take action to establish or strengthen procedures that safeguard assets, reduce the risk of fraud, and improve the financial reporting process. As a result, the company will have more effective and efficient financial reporting and accounting processes, which may lead to even more operational efficiencies.
At Cray Kaiser, we recognize that every business has unique needs and considerations when it comes to audits. If you have questions about whether an audit may be right for your business, contact us today.