Undergoing a financial audit is a significant endeavor. Between planning, preparation and fieldwork, engagements frequently last up to three months, during which other financial management tasks still demand attention.
At large enterprises, finance teams and processes are more mature, making it easier to handle the burden. However, many small and medium-sized businesses (SMBs) face audit requirements before reaching that stage of development.
This guide explores how to prepare for a financial audit when your company is still growing rapidly, your processes have some room to mature, and your finance team is still relatively lean.
What Is a Financial Audit and How Does It Work?
A financial audit is the process by which an independent Certified Public Accountant (CPA) firm determines whether your financial statements are presented fairly in accordance with a financial reporting framework.
In practical terms, its purpose is to provide “reasonable assurance” that your accounting is trustworthy. This gives external stakeholders—like lenders, investors and regulators—the confidence to make decisions using your financial statements.
For instance, startups often have to provide a clean audit report to secure venture capital funding, typically beginning with the Series B or Series C rounds.
Because examining every single line item in your general ledger would be prohibitively time-consuming, auditors use a risk-based approach to test the areas of your accounting most vulnerable to fraud or error. For example, that may include:
- Evaluating the strength of internal controls
- Confirming account balances with third parties
- Vouching sample transactions to original documents
- Inspecting inventory and other physical assets
- Reviewing variances between current and previous periods
- Searching for unrecorded or understated liabilities
As the subject of an audit, you’re responsible for providing the documents auditors need to perform these tests upfront. You must also be ready to provide ongoing support, such as by answering technical questions and fulfilling additional documentation requests.
How to Prepare for a Financial Audit
The sooner you start preparing for the audit process, the easier it’ll be to manage. Generally, you should budget at least three to six months for audit preparation, especially for your first time.
When that window approaches, here’s a step-by-step framework you can follow.
1. Communicate With Your Auditors
If you’re already in discussions with an auditor, don’t be afraid to ask them for guidance on how to prepare. Remember, they’re your partners in this process, not your opposition. They want things to go just as smoothly as you do.
Your auditor can help you understand which documents you’ll need to provide, what the timelines are for each portion of the engagement, and other details that are unique to your individual circumstances.
2. Clean Up Your Accounting System
Consider revisiting your accounting fundamentals, especially if this is your company’s first financial audit. Make sure that your chart of accounts (CoA) is organized logically and that you’re categorizing transactions of the same kind consistently.
In a similar vein, review your records for any significant miscellaneous or catch-all accounts. Auditors frequently scrutinize these, so preemptively reclassifying them into more specific categories can save time later.
3. Ensure Compliance with Accounting Standards
Determine which financial reporting framework your auditors will expect you to follow and make sure you’re in compliance. While many assume this means Generally Accepted Accounting Principles (GAAP), that’s not necessarily the case.
Full GAAP compliance is costly and challenging to implement, especially aspects like leases and stock-based compensation. Many SMBs can get away with special purpose frameworks, also known as other comprehensive bases of accounting (OCBOAs).
These are less expensive to maintain and easier for financial statement users to understand, while still providing sufficient transparency for specific stakeholders. Some common examples include the modified cash basis, tax basis and regulatory basis.
4. Perform a Hard Year-End Close
In addition to ensuring that your financial statements are compliant, you’ll need to perform a hard close on the books. This is the process of finalizing your accounting records for the period under audit.
For example, that typically includes steps like:
- Reconciling all accounts and vouching balances to supporting documentation
- Tying out balances across the financial statements to ensure consistency
- Confirming completeness by recording all liabilities and outstanding obligations
- Posting adjusting entries for items such as accruals and depreciation
Completing a clean year-end close ensures that your auditors can work from a fixed set of financial statements. If your books need constant updates during the audit, it can disrupt the process and potentially undermine the outcome.
5. Update Internal Controls Documentation
After reviewing your accounting system, confirming compliance and closing the books, it’s a good time to update your documentation of internal controls. Auditors must evaluate their design and implementation as part of every financial audit.
Generally, you should be documenting how key financial processes work and who’s responsible for them. For example, that typically includes approval workflows, segregation of duties and information technology (IT) details.
Make sure the controls documentation you provide to your auditor reflects any changes in your tech stack, personnel and workflows since the last time you updated it.
6. Put Together Your PBC List
The prepared by client (PBC) list is a checklist of documents, reports and schedules your auditor will need from you to perform their audit procedures. If you’ve already selected an auditing firm, ask for their PBC list and start putting together the materials.
If you don’t have one, find a standard PBC list instead. These vary depending on the type of company and audit involved, but common items beyond internal control documentation include:
- General ledger and trial balance reports
- Bank account and credit card statements
- Supporting schedules for major balance sheet accounts
- Payroll reports and employee compensation records
- Major contracts, such as leases or employment agreements
- Corporate documents, including bylaws and board meeting minutes
In addition to documentation for the audit period, auditors often request records from the months immediately following year-end. For example, they may review your next few bank statements in their search for unrecorded liabilities.
7. Define Audit Request Workflows
Auditors will inevitably make more requests of you as they perform testing, whether that’s for additional documentation or technical clarification. Make sure you define clear policies for how you’ll handle those requests before the auditor begins their fieldwork.
Perhaps most notably, determine who will be responsible for what tasks. This should involve confirming your main points of contact with the audit team and assigning ultimate ownership over individual aspects of the audit process, like accounts payable.
Distributing responsibilities across your team helps balance the workload and prevents important requests from falling through the cracks.
When to Seek Audit Readiness Services
Preparing financial statements for an audit with a lean finance team can be a major challenge. If you lack the expertise or capacity to handle everything internally, fractional support can help fill those gaps without the hefty overhead of a full-time hire.
This is often invaluable when you have to adopt a complex reporting framework you’re unfamiliar with. For example, transitioning to GAAP often requires sophisticated adjustments that your accounting staff may not have experience implementing.
Seeking support proactively is typically more efficient than waiting to address known deficiencies during an audit. If auditors discover compliance or control gaps during fieldwork, fixing them can increase costs significantly and delay the engagement.
If these issues are significant enough, they could even affect the outcome of the audit, potentially resulting in a qualified or adverse opinion. Taking steps to resolve them ahead of time keeps the audit process efficient and preserves stakeholder confidence.
Find Expert Audit Prep Support With Paro
Preparing for a financial audit while juggling day-to-day responsibilities can stretch even the strongest finance teams. It’s especially challenging when you’re growing quickly, operating without a CFO, or navigating complex GAAP-reporting requirements.
Whether you need additional capacity or specialized expertise, Paro can connect you with experienced audit professionals who can fill your audit preparation gaps. Schedule a free consultation to get started today.
