Public companies must submit quarterly and annual financial statements to the Securities and Exchange Commission (SEC) for audit preparation. Your business will need a financial audit whether you’re raising Series A funding or preparing for an IPO.
Material misstatements in financial statements remain a serious concern for auditors. Independent third-party CPA firms conduct financial audits to verify your organization’s financial statements are fair and accurate.
The audit preparation process can feel overwhelming. We created this complete guide to help guide you through each step – from setting up strong internal controls to organizing your documentation.
Want to make your next audit smoother? Let’s take a closer look at the steps you need to prepare audit-ready financials.
Understand What Auditors Look For
Your preparation for an audit starts with knowing what auditors look for as they review your records. Financial auditors use specific methods and standards to review your financial statements.
What is a financial audit and why it matters
Qualified professionals, usually independent certified public accountants, conduct a complete examination of your company’s financial records in a financial audit. Auditors review financial statements carefully to confirm accuracy, check compliance with regulations, and make sure the information shows your organization’s true financial position.
Financial audits are the life-blood of confidence in the financial system. These audits add credibility when stakeholders need to trust that your financial statements show your company’s real position and performance. The audit process helps:
- Stop fraud and dishonest dealings
- Show compliance with regulations
- Find inefficiencies in your processes
- Spot possible fraud threats
It’s worth mentioning that audits provide reasonable assurance rather than absolute certainty about financial statements being free from material misstatements. Auditors check samples of transactions instead of looking at every single one.
Types of audit opinions and what they mean
Auditors give one of four opinions after completing their work to show how reliable your financial statements are:
- Unqualified/Unmodified Opinion: This “clean” opinion shows the best possible outcome. Your financial statements present a fair picture of your company’s financial position.
- Qualified Opinion: Your financial statements are mostly fair, but with specific material exceptions that don’t affect everything.
- Adverse Opinion: The worst outcome shows major problems or misrepresentations in your financial statements.
- Disclaimer of Opinion: Auditors can’t form an opinion because they lack evidence or independence.
Common triggers for financial audits
Regular audits happen routinely, but several factors might increase your business’s chances of facing an audit:
- Wrong income reports or inconsistent tax and financial records
- Too many deductions compared to income
- Business losses that keep happening year after year
- Many unexplained cash transactions
- High business entertainment deductions
- Workers wrongly classified as independent contractors
- Big purchases that seem beyond your means
Some organizations must have audits by law. Public companies need them for SEC requirements. Organizations getting federal funds over $1,279,207.70 need Single Audits. Businesses with specific loan agreements might also need audits.
Knowledge about what catches auditors’ attention helps you prepare your financial records and documentation better for the audit process.
Get Your Financials in Order
The foundation of audit-ready financials lies in consistent financial processes throughout the year, not just before an audit begins. Let’s learn about everything that builds the foundation for a successful audit.
Close your books monthly
Monthly closings give you timely financial insights and make your year-end audit smoother by a lot. The team can identify and correct errors earlier if books close monthly, which prevents small issues from becoming major audit findings. Financial experts point out that companies with regular monthly closings experience fewer audit adjustments and shorter audit completion times.
The monthly closing process should include:
- Bank and credit card accounts need reconciliation right after month-end
- Revenue earned but not yet invoiced must be recorded
- Documentation of expenses incurred but not yet paid
- A standardized month-end checklist ensures consistency
Reconcile key balance sheet accounts
Balance sheet reconciliation serves as the life-blood of audit preparation and financial accuracy. The process compares your general ledger balances with supporting documentation to ensure they match. Studies show that 88% of all spreadsheets contain all but one error, which highlights why systematic reconciliation matters.
These key accounts need reconciliation:
- Cash balances against bank statements
- Accounts receivable against customer ledgers
- Accounts payable against vendor invoices
- Fixed assets against depreciation schedules
- Inventory against physical counts
Review revenue and expense cutoffs
Accrual-basis accounting makes timing matter a lot. Auditors look specifically for proper cutoff implementation to ensure revenues and expenses appear in the correct accounting period.
Note that revenue recognition happens when earned, not when cash comes in. Similarly, expense recording should occur in the period they’re incurred, not when payment happens. Auditors test cutoff compliance through shipping documents, customer invoices, and transactions near period-end dates.
Accruals (expenses incurred but unpaid) and prepaid assets (expenses paid but benefiting future periods) need extra attention as they often trigger auditor scrutiny.
Organize and Document Everything
Detailed documentation is the foundation of a successful audit process. Auditors need supporting evidence to verify the numbers presented in financial statements. Let’s get into how to make your audit documentation work effectively.
Create an audit preparation checklist
A detailed audit preparation checklist will give a clear path so nothing slips through the cracks. Your team can track progress and maintain consistency throughout the process with these checklists that provide structure and framework.
A well-laid-out audit preparation checklist should include:
- Financial statements and reconciliations
- Trial balance and general ledger reports
- Bank statements and reconciliations
- Supporting documentation for revenue and expenses
- Inventory counts and valuation details
- Fixed asset records and depreciation schedules
Note that creating categorized folders with standardized formats for your documentation substantially reduces anxiety and increases accuracy during the audit process.
Gather contracts, leases, and agreements
Auditors carefully review these documents, so collecting all relevant contracts becomes crucial. You should focus on:
Service agreements contain embedded leases that must be properly identified and factored in. Your financial statements can be substantially affected if you don’t identify embedded leases in service contracts with recurring payments.
Contract review should include those in different currencies. You need to capture historical conversion rates from the contract start date. On top of that, documents related to regulatory compliance, licenses, and insurance policies need proper organization.
Prepare supporting schedules and workpapers
Lead schedules (also called lead sheets) work as summaries and indexes of financial statement line items. These valuable reference points show which general ledger accounts make up each line item in your financial statements.
Supporting schedules need to stay accurate through cross-referencing data with general ledger and other financial records. This integration helps the data in supporting schedules line up perfectly with figures in your primary financial statements.
Your documentation should be ready early. Documentation created after the audit starts tends to be less accurate than work done at the time of transactions.
Work With Your Auditor Effectively
Your relationship with your auditor matters just as much as having accurate financial records. The audit’s success depends on how well you work with your audit team.
Hire the right auditor for your business
The quality of your audit depends on picking the right audit firm. Here’s what you should think about when choosing an auditor:
- Industry expertise – Find auditors who know your sector and understand your business operations and industry challenges
- Qualifications and certifications – Make sure potential auditors have the right credentials for your needs
- Reputation and track record – Choose a reputable firm that will deliver quality work
Note that price shouldn’t be your main concern when picking an auditor. Yes, it is tempting to go with lower fees, but this could reduce the audit’s value and create more risks for directors and investors.
Understand the PBC (Prepared by Client) list
A PBC (Provided By Client) list shows everything your auditor needs to do the audit right. This list has balance sheet accounts, revenue and expenses, cash flow documents, and other materials that affect your finances.
Your auditor should send the original PBC list 30-60 days before starting. This gives you time to prepare and avoid surprises. Quick responses to PBC requests will cut down audit time and costs.
Maintain open communication during the audit
Good communication builds trust and respect between you and your auditors. Here’s how to make shared work better:
- Pick someone knowledgeable to talk with auditors
- Set up regular meetings during the audit
- Create ways to get feedback from auditors
- Let your audit committee meet auditors without managers present
The “no surprises approach” – keeping open talks between you and your auditors – helps solve problems quickly. This way, everyone understands and accepts the findings.
Conclusion
Creating audit-ready financials just needs attention to detail and consistent effort throughout the year. Your confidence in financial reporting grows when you have strong internal controls, regular reconciliations, and thorough documentation that substantially reduce audit-related stress.
Successful audits come from proactive preparation instead of reactive scrambling. Future audits become smoother and more efficient when you establish solid financial processes, keep well-organized records, and build shared relationships with auditors.
Business owners discover that time invested in audit preparation leads to shorter audit durations, fewer adjustments, and cleaner opinions. These practices can revolutionize your next audit from a dreaded ordeal into a manageable process that adds value to your business when you start implementing them today.
FAQs
Q1. What are the key components of audit-ready financials?
Audit-ready financials include accurate financial statements, regular account reconciliations, proper revenue and expense cutoffs, organized documentation, and supporting schedules. Maintaining these components throughout the year helps ensure a smoother audit process.
Q2. How often should I close my books for better audit preparation?
It’s recommended to close your books monthly. This practice allows you to identify and correct errors early, provides timely financial insights, and significantly reduces the likelihood of major audit findings at year-end.
Q3. What types of documents should I gather for an audit?
You should gather financial statements, bank statements, contracts, leases, agreements, inventory records, fixed asset schedules, and supporting documentation for revenues and expenses. Creating an audit preparation checklist can help ensure you have all necessary documents ready.
Q4. How can I effectively work with my auditor?
To work effectively with your auditor, hire one with relevant industry expertise, understand and promptly respond to the PBC (Prepared by Client) list, maintain open communication throughout the audit process, and designate a knowledgeable point person to liaise with the audit team.
Q5. What are common triggers for financial audits?
Common triggers for financial audits include misreporting income, disproportionate deductions relative to income, repeated business losses, large unexplained cash transactions, excessive business entertainment deductions, and misclassification of employees as independent contractors. Some organizations, like public companies, are also subject to mandatory audits.
