Complete Guide to Financial Audits: From Preparation to Final Report

Every business leader knows how necessary it is to be fully accurate with financial information. 

They also know that the words financial + audit are the plot of their nightmares.

Why? 

Financial audits have built a somewhat dreadful reputation, but in reality? They're how you and your partners make sure the business is on the right track, financially speaking.

So if you have a financial audit lined up soon, it might be time to recognize how important it is.

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What's a Financial Audit?

It's a third-party assessment of a company's financial transactions and records. Usually, it's carried out by a certified public accountant (CPA) or an audit firm.

A financial audit is a completely objective analysis of your financial status, making sure everything follows the general rules like GAAP or IFRS.

While it sounds like a pretty official business, it shouldn't worry you too much, as the result is definitely going to help you lead your operations to a healthier financial state.

We are going to get into all the details in a minute, but let's begin reviewing what a financial audit covers:

• Income statements, balance sheets, and, of course, cash flow statements.
• Accounting policies and how you apply those to daily operations.
• Internal controls, quite important to prevent fraud.
• Relevant estimates 

At the end of the audit, you’ll get an audit report that includes the auditor’s opinion.

If everything looks good, you get a clean or unqualified opinion, which is kind of like a gold star for your financial statements.

See? 

Nothing to worry about

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Types of Audits

While the above is the general definition of a financial audit, sometimes things can look slightly different. 

Depending on your situation, like maybe you don't run a business but a nonprofit organization, there are specific types of audits, each one serving unique purposes.

External audits

This is the most common for private companies. The goal is to determine how accurate and honest your financial statements are, based on industry standards like the GAAP. 

External audits are key to showcasing and maintaining your company's credibility in front of the market.

Internal audits

Closely related to risk management, this audit is performed by your own people or perhaps by a hired consultant. You can see it as a preliminary step before an external audit. 

The major difference is that this audit will not only cover your financial records but also put an extra emphasis on how well your processes and internal controls are functioning.

Compliance audits 

At first glance, it isn't a financial audit, but bear with us for a second.

A compliance audit doesn't check the numbers, but yet is how you make sure you are playing by the book.

For example, nonprofits that receive government grants may need to prove that the funds are being used appropriately. 

Or a business might undergo a compliance audit to meet tax or environmental standards.

Forensic audits

See this one as the consequence of a possible red flag. 

Forensic audits are performed when you suspect there's something wrong with your company's finances.

Something like…fraud or other legal issues.

The goal here is a bit different, as it's commonly used to find evidence that things have gone wrong in your company.

Differences between accounting and auditing 

Accounting and auditing might be related in the sense that both work with the financial aspect of businesses. 

That being said, they work in different spaces. 

Accounting focuses on recording and organizing all your financial transactions.

Auditing, as we've seen, deals with the post-work part of it.

Auditors don’t recreate the book; they evaluate whether the existing ones are accurate, complete, and in line with the rules.

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What Documents are Audited? 

Besides the fear…

This is the first thing people think about when audits are mentioned.

What the heck do I need to collect?

Well, the answer isn't as straightforward as it should be. Some auditors might ask you for a specific list of documents, while others might work just fine with the basics.

All in all, these are the most popular ones.

Account balances

This is a must-have regardless of your type of company.

Auditors will take a close look at your account balances, things like cash, receivables, payables, inventory, and equity. 

They’ll compare what’s in your books to supporting documentation, like bank statements or general ledger reports, to make sure the numbers match up and nothing’s been overstated or missed.

Historical documents

Good research needs some context after all.

And financial audits aren't different. So if an auditor asks you to prepare historical information, go over your financial and procurement systems to gather relevant invoices, purchase orders, or data from the past year that makes it easier to detect patterns or the long-term impact of your financial policies.

IRS documentation 

Tax filings, such as income tax returns, payroll tax filings, and 1099s, are often reviewed to make sure the numbers reported to the IRS are a perfect reflection of what’s in your books. 

Internal policies 

Policies, policies

They're everywhere and with good reason.

The success of a financial audit doesn't rely solely on how great the numbers look; that's an important part, sure, but so it's studying the effectiveness of your company's internal controls, like who approves payments, how expenses are reviewed, or how cash is handled.

Financial commitments 

It's not only about profits

It's also about responsibilities.

This includes contracts, lease agreements, loan documents, or long-term obligations. Auditors check that all your financial commitments are properly accounted for in your books and that future liabilities are properly recorded.

Financial statements 

The core of the whole process?

It's here

Balance sheets, income statements, cash flow statements, and any accompanying notes.

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Benefits of a financial audit 

Provides accuracy 

For all its scary reputation, financial audits are highly useful for your business.

First, it's a good motivation to always work under the rules, following a clean system of financial records. 

Secondly?

It's probably the most comprehensive picture you're going to have of your real financial status.

Builds trust with external parties 

Maybe you don't have plans to ask for a loan anytime soon, but what about attracting some powerful investors?

Yeah, that's always an appealing idea. 

One of the biggest advantages of putting your company under a financial audit is the credibility it builds in front of people. 

Knowing that your finances are strong and absolutely honest sends a positive message to the market.

Identifies internal issues 

We said it above 

During the audit process, auditors don’t just look at the numbers; they also review your internal controls. 

How do you manage cash?  What are your strategies to prevent fraud? How do you track approvals?  If something looks risky or inefficient, they’ll point it out. And that’s a good thing.

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It’s the perfect opportunity to tighten up your processes and reduce the chance of errors or losses down the road.

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The Process of Financial Audits 

Planning and risk assessment 

• The auditor is going to come to meet you and your team to learn about your operations.
• They'll start by going over previous audits, if any, and internal reports
• Identifying areas with a higher risk of errors or fraud, like revenue recognition or inventory, is generally the next step. 
• They'll also set a materiality threshold.

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Test internal controls

• Who approves purchases or payments?
• How is access to financial systems controlled?
• Are reconciliations done regularly?

Evaluation 

This is the part where the auditors are going to spend the majority of their time working on. 

Remember all the documents we listed? 

Yeah, it's time to sit down and see if all is good as it seems.

Final review and reporting 

After all the testing is complete, the audit team reviews its findings and prepares the audit report. This includes:

• A summary of their work
• Any issues or inconsistencies they found
• Their official opinion on whether your financial statements are fairly presented

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Financial Audit Checklist 

 Documentation needed

• Complete financial statements (income statement, balance sheet, cash flow, and footnotes)
  
  
• General ledger and trial balance
  
  
• Bank statements and reconciliations for all accounts
  
  
• Accounts receivable and payable reports with aging summaries
  
  
• Payroll records and tax filings (W-2s, 1099s, etc.)
  
  
• Invoices and receipts for major transactions
  
  
• Fixed asset register and depreciation schedules
  
  

 Internal controls and policies

• Written financial policies and procedures
  
  
• Segregation of duties clearly documented (who does what)
  
  
• Expense approval workflows and documentation
  
  
• Controls for cash handling and digital access
  
  

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Legal aspects to care for

• IRS correspondence and tax returns
  
  
• Loan agreements, leases, and contracts
  
  
• Documentation of any legal claims or contingent liabilities
  
  
• Prior year audit reports and follow-up actions
  
  

 Communication and additional tasks

• A point person assigned for the audit (your internal go-to)
  
  
• Timelines and key dates agreed with your auditor
  
  
• Open issues or complex estimates discussed ahead of time
  
  
• Management representation letter drafted and reviewed
  
  

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