What Is a Financial Audit and How To Prepare One

The financial audit is one of the essential accounting processes that confirms the accuracy of critical financial statements.

No matter how large or small your organisation is, you may rely on income statements, balance sheets, cash flow statements, and other documents to demonstrate your company’s financial health and position. 

However, unless a financial audit is performed, your financial reporting processes and data collection are not guaranteed to be effective and reliable and to produce accurate data.

In the following sections, we explain what a financial audit is, how it’s conducted, why it matters, and more.

What is a Financial Audit?

Before we dive into the details, let’s take a moment to cover the basics.

What is a financial audit in the first place?

A financial audit or financial statement audit is a yearly audit of a company’s financial statements. It aims to determine whether the financial records are correct and precise and accurately portray the business’s financial transactions.

The audited financial statements are examined annually by independent financial auditors using Generally Accepted Accounting Principles (GAAP) standards, establishing an audit opinion based on the auditor’s findings. 

These statements include:

• Balance sheet;
• Income statement;
• Cash flow statement. 

The GAAP outlines the specific requirements and accounting standards for processing and demonstrating financial data to stakeholders, guaranteeing that the organisation’s financial performance is represented accurately.

The Importance of Financial Audits

Financial audits are fundamental as they ensure that businesses abide by legal requirements. In addition, they provide reasonable assurance that all financial data presented is truthful and unbiased.

In many cases, lenders demand external audit discoveries for debt covenants. For some businesses, financial audits are required by law (for instance, publicly traded companies must have their internal controls examined).

In a nutshell, financial audits are essential for the following reasons:

• Exposure of errors: Financial audits help expose errors and data misrepresentation that may remain hidden. Comparing financial information from year totals, trial balances, and other sources allows companies to detect vital issues in reporting.
• Fraud prevention: The audit’s process features internal controls reviewing, meaning modifications in accounting estimates or incorrect payment requests can be spotted. This can help uncover fraud risks, allowing the business to take measures to prevent them.
• Cost savings: Financial audits also spot potential opportunities for improvement by closely analysing the company’s financial performance and data accuracy, ultimately resulting in cost savings.
• Better resource allocation: Most importantly, financial audits can help an organisation’s management make better-informed decisions about allocating capital and other resources to specific parts of the business. The audit can help prevent under- or overspending in the long run.

These are just some examples of why a financial audit is necessary for companies of all sizes.

Internal and External Audits

Although all financial audits share a common purpose, three different types stand out with critical points of differentiation: external financial audits, internal financial audits, and internal revenue service audits or IRS audits.

Here’s what you need to know about each one.

External Financial Audits

As the name suggests, external financial audits are usually performed by external auditors who are part of an Independent Certified Public Account Company (CPA).

During an external financial audit, certified public accountants conduct financial statement audits, review accounting policies, and internal controls to detect any material misstatements(according to generally accepted auditing standards, misstatements in financial statementsare categorised as material in cases where they influence a user’s judgement and decisions).

This process enables these chartered accountants to confirm whether the organisation’s financial statements are accurate and whether the company’s accounting practices meet all requirements. This is incredibly important for regulatory bodies and stakeholders. 

In most cases, external auditors state the internal audit’s reliability by analysing audit evidence. Together with the financial statement, the external financial audit is key to assessing a company’s financial performance. It allows investors and analysts to gain confidence in a business.

Internal Financial Audits

On the other hand, internal auditors perform internal audits (employees who are part of the organisation and are tasked with evaluating the effectiveness of financial reporting and the reliability of the company’s internal controls). 

Overall, the main goal of an internal audit is to detect any potential areas for improvement by analysing the existing internal control systems and reporting practices. 

Certified internal auditors often partner with external auditors to better understand the company’s accounting practices.

IRS Audits

Lastly, an IRS audit analyses a person’s or company’s accounts and financial information. This audit aims to ensure financial data is presented fairly and correctly to tax authorities in accordance with tax laws, ensuring financial accuracy. 

Based on the findings of the IRS audit, there are several potential outcomes. Ideally, the auditor discovers that no changes need to be made.

However, in some cases, the auditor’s opinion is that changes need to be made and the taxpayer agrees and complies. In other cases, the taxpayer does not agree with the suggested changes and can demand a meeting with an IRS manager or take other actions.

Before taking action, taxpayers must review tax planning and returns in detail to familiarise themselves with every piece of information and how it was calculated.

Preparing for a Financial Audit

Now that we’ve covered the basics, it’s time to learn how to prepare for a financial audit.

Audit planning includes:

• Collecting all essential documents.
• Analysing previous reports.
• Organising financial statements.
• Reconciling accounts and transactions.
• Providing access to financial records.

More information about the steps will be provided in the below lines, so read on.

Gathering The Necessary Financial Documents

The typical audit reviews a range of different financial documents.

To get started, make sure you have access to everything you need, including:

• Account balances and transactions;
• Historical documents;
• IRS documentation;
• Internal documents;
• Commitments;
• Financial statements.

You may need to collect income statements, balance sheets, cash flow statements, tax returns, bank statements, statements from invoicing software, and even contracts and agreements. This will help you go through the audit without interruption, allowing you to analyse all of the data you need. 

Reviewing Previous Audit Reports

Next, you’ll need to review any previous financial reports from audits. 

The data from these reports can provide crucial insights into any challenges or problems recurring over time.

It can also expose any previous discrepancies and show suggestions or advice given by auditors who have been involved in the process in the past.

Organising Financial Statements

Ensure that all financial statements you can access are adequately organised, enabling you to progress towards the audit.

Some things to look for include consistency, up-to-date information, and format clarity. 

Ensure all statements are created based on accounting standards and reflect the latest transactions.

Reconciling Accounts and Transactions

The next fundamental stage of preparing for the financial audit relates to reconciliation. This phase tests internal records against external statements, proving that all balances match.

Some of the core areas to focus on include:

• Bank statements and cash balances;
• Accounts receivable and accounts payable;
• Intercompany transactions;
• Company inventory and physical inventory.

This stage will help you guarantee no discrepancies to worry about throughout your audit.

Ensuring Compliance With Regulations

Finally, make sure that all documentation and practices abide by laws and regulations. 

For example, confirm that the company’s taxes are appropriately calculated and paid. Check things like the income tax, sales tax, payroll tax, and other taxes you may be responsible for.

If there are any industry-specific regulations that you must comply with, ensure that you’re aware of this and that measures have been taken to guarantee compliance.

Conducting the Financial Audit

Once you’ve prepared for your financial audit, you can proceed to the actual performance stage.

First, select a reliable and qualified auditor for the process. No matter whether you choose to work with an internal or external auditor, guarantee that they have the necessary licences, experience, and professionalism.

Remember that the financial audit auditor must be a Certified Public Accountant (CPA) or a Chartered Accountant (CA).

Next, you need to provide access to financial records and information.One of the most important factors for financial audits is transparency. Access all accounting records so your auditor can work with confidence, transparency, and professionalism. 

In some cases, physical visits may be required so the auditor can access physical records. If your financial records are predominantly stored online, make sure you can provide login details or access to the systems you have in place.

Coordinate this with your financial department, HR, IT, and any other teams that may need to be involved. 

Post-Audit Actions

You may be tempted to rest once the financial audit has been completed, knowing that the procedure is finalised.

However, you’ll be required to take several post-audit actions.

Reviewing The Audit Findings

Set some time aside to review the audit findings and the recommendations made by the auditor. You may find that discrepancies have been discovered, problematic areas or actions are required.

Carefully analyse all of these findings and act as instructed. Share these insights with stakeholders, such as senior management, your board of directors, and others. 

This will guarantee that everyone in the organisation is on the same page and aware of the next steps.

Implementing Audit Recommendations

The ultimate goal of the financial audit is to provide your organisation with suggestions on how to enhance its financial practices and comply with regulations. 

To achieve this, make sure you precisely implement the auditor’s recommendations as soon as possible. 

Make a list of priorities, create an actionable plan to share with your team, and remember to track your progress. 

Correcting Identified Discrepancies

In most cases, financial audits will reveal discrepancies you may have never suspected.

If this is the case, adjust financial records to eliminate any mismatches. If the spotted discrepancies are substantial, it may be best to reanalyse and reissue all financial statements. 

Ideally, you should try to detect the root cause and optimise your processes to prevent potential risks in the future.

Strengthening Internal Controls

Moreover, your financial audit discoveries can help you improve your internal controls, minimise fraud, and guarantee adequate financial reporting. 

If you’ve noticed any weaknesses, place new procedures to fill the gaps. Depending on the type of findings you’ve received from the audit, implement new internal controls to guarantee stricter authorisation processes, better resource allocation, and more.

Documenting The Audit Process

The steps you go through during the audit are incredibly important as they can shape future audits. 

In addition, they’re essential for accountability, transparency, and future reference. Explain the process and record it in detail, making it available to all involved parties. 

Tools and Tips to Help The Process

From what we’ve covered, it’s clear that performing a financial audit isn’t easy. The process requires time, experience, and attention to the smallest details. Luckily, with the right tools at your fingertips, you can simplify the process and ensure higher levels of accuracy.

Some of the solutions you can rely on include:

• Accounting software;
• Document management systems;
• Audit management solutions;
• Data analytics tools;
• Checklists and templates.

When considering tools to help with your financial audits, research their pricing, available features, and customer support. In addition, perform regular financial audits. This can help you prevent repeating mistakes that you haven’t identified in the past, saving you time, effort, and, most importantly, money.

Conclusion

Financial audits, as mandatory as they are, can be highly multifaceted and complex. 

This article will help you gain a more granular understanding of the topic, enabling you to choose your auditors wisely and ensure compliance with regulations. 

No matter how big or small your company is, consider the importance of these financial audits for your business.

Frequently Asked Questions

What do auditors look for during a financial audit?

During a financial audit, certified auditors analyse data to uncover misrepresentations of financial records and assess the reliability of internal controls. The audit consists of substantive procedures and substantive testing that ensure the audit is complete and adequately performed.

Why should you conduct a financial audit?

Financial audits must be conducted to confirm that a company’s financial statements are accurate and reliable.

Are all financial audits the same?

Although financial audits are conducted for the same purpose, there are different types of audits based on who performs them and what documents they analyse. Internal, external, and IRS audits are also conducted.