Companies often struggle with their first external audit because they put off preparing until a stakeholder requests one. This can mean having to overhaul years of financial controls under a hard deadline—usually at a pivotal point in the business’s growth.
In this guide, we’ll provide a framework for evolving internal controls alongside your business, show you how to pressure-test them using the internal audit process and discuss when it makes sense to bring in fractional audit assistance.
Why Growing Companies Struggle With Their First External Audit
Early-stage startups tend to optimize their finance functions for efficiency. This typically means adopting simple controls and practical workflows that minimize administrative burdens, helping the business pursue growth more efficiently.
However, as companies expand, these lightweight controls often become steadily less effective. Informal processes that used to work well start to create control gaps and operational bottlenecks.
The longer this issue goes unaddressed, the harder it becomes to fix. Historical data accumulates, transaction volume increases, and financial operations get increasingly complex, making weaknesses harder to find and resolve.
This is how many growing companies get into trouble. They delay updating aspects of their control environment until a lender, investor or acquirer requests an external audit, forcing the company to scramble under a tight deadline.
In many cases, one of the most effective ways to right-size internal controls is to establish a proactive internal audit process early. This helps ensure external audit readiness grows alongside the business, rather than becoming a last-minute project.
What External Auditors Look For
Growing companies often face their first external audit ahead of a significant fundraising round, financing arrangement, or mergers and acquisitions (M&A) transaction. In these cases, stakeholders want assurance that the company’s financial reporting and internal controls are trustworthy.
To that end, external auditors generally look for evidence of:
- Clear ownership and segregation of duties
- Consistent documentation, approvals and reconciliations
- Timely, accurate financial reporting in compliance with accounting standards
As a result, informal processes become a liability at this point. If your control environment still depends on tribal knowledge or undocumented routines, you risk negative audit findings and remediation work that could disrupt prospective deals.
Audit Readiness for Growing Companies
Introducing rigid controls too early creates an unnecessary administrative burden, but waiting too long can leave your finance team scrambling before an external audit. Let’s explore a framework to help you strike the right balance as your company grows.
Stage 1: Founder-Led Operations
In the earliest stages of a company’s growth, everything tends to fall on the shoulders of the founding team. With only a handful of people involved, formal segregation of duties and rigid approval structures can be unrealistic or create unnecessary friction.
As a result, the goal during this period should typically be to establish healthy practices that reduce your exposure to obvious risks—without slowing down operations. For example, that might include:
- Keeping financial records organized from the beginning
- Ensuring all founders have visibility into financial activities
- Reviewing expenditures above a certain threshold together
The purpose of these habits isn’t necessarily to satisfy future audit requirements, but to address your most significant vulnerabilities and pave the way for you to implement stronger controls as the business grows.
Stage 2: Formalize Financial Controls
As transaction volume increases and the finance team expands beyond founders, informal oversight gets harder to maintain. Functions that depended on constant communication start to require clearer ownership and more consistent execution.
At this point, the next step is to move away from founder-dependent processes and establish controls that employees can execute consistently. That means formally documenting key procedures and controls, such as:
- Basic segregation of duties
- Payment approval workflows
- Reconciliation and close processes
In addition to establishing the foundational documentation that your future external auditors will eventually expect, this clarity can improve efficiency and consistency in day-to-day operations.
Stage 3: Keep Controls Aligned
Financial processes rarely stay the same for long at growing companies. New products and services, employees and software systems can all introduce risks that existing controls weren’t designed to address.
As a result, finance leaders should regularly evaluate whether controls still reflect actual operations. For example, consider how workflows have changed since the last review and whether those shifts might have created control gaps.
As operations and controls evolve, finance teams should update documentation to match. Keeping records of policies and procedures current helps you avoid scrambling to update them ahead of an upcoming external audit.
Stage 4: Prepare for External Scrutiny
Don’t wait for a stakeholder to request an audit before you start preparing for one. Instead, evaluate your audit readiness as soon as you start exploring something that could trigger external scrutiny, such as a major fundraising round or acquisition.
Finance teams should confirm that controls operate consistently across departments and leave enough evidence for evaluation. They should also prepare to provide control walkthrough support and answer auditor questions about their responsibilities.
Once your first external audit is officially on the calendar, your auditor will be able to provide additional guidance on the specifics of their evaluation. Ideally, you should use that insight to find and close any remaining gaps in those areas before testing begins.
How to Use the Internal Audit Process to Assess Audit Readiness
The internal audit process is often more effective as an ongoing function than as a one-time drill ahead of an external audit. Many companies can benefit by introducing it when they first formalize controls, then expanding its scope alongside the business.
From then on, you should conduct regular internal audits at a frequency that suits your business. For example, a quarterly cadence maximizes your odds of catching control issues early, but annual reviews are less burdensome for your team.
In any case, make sure your internal audit checklist:
- Maps each test to a specific financial risk;
- Identifies who is responsible for each control;
- Defines how the control should operate; and
- Specifies how auditors will verify the control’s effectiveness.
As important as internal controls are, you may not be able to remediate each gap you find immediately. In practice, consider prioritizing material control weaknesses that affect financial reporting or compliance, then addressing lower-risk findings over time.
Common First-Time Internal Audit Findings Examples
It’s not unusual to discover weaknesses in your control environment during your first internal audit, especially if administration has historically taken a back seat to growth. Here are some of the most common issues to watch for:
- Revenue recognition inconsistencies: Your team might recognize revenue too early or handle similar transactions differently across customers. ASC 606 issues can skew financial reporting and disrupt future external audits.
- Undocumented approval processes: Employees may follow the right approval process without leaving a clear record that they did. In an external audit, an unverifiable control often creates the same concerns as one that doesn’t exist.
- Weak reconciliation discipline: Teams often fall behind on bank reconciliations as transaction volume grows. If left to accumulate for months at a time, even minor discrepancies can become challenging to resolve.
- Excessive reliance on one employee: An individual may become responsible for an entire financial process or be the only person who understands how it works. That creates operational risk and makes consistent execution harder.
- Inadequate access controls: Employees sometimes keep system permissions they no longer need after changing roles. Over time, unnecessary access increases the risk of errors, fraud and unauthorized activity.
Finding these issues during an internal audit is much better than discovering them during an external one. Addressing them early gives your team more flexibility to strengthen controls without working against an audit deadline.
When to Bring in Fractional Finance Leadership
Audit preparation can be a significant challenge for lean finance teams, especially when they’re also supporting other strategic initiatives, like fundraising or acquisitions, or lack experience with full-scale external audits.
In these cases, fractional CPAs and controllers can be a powerful way to bridge any gaps in bandwidth or expertise. For example, they can often help with aspects of audit readiness like:
- Reviewing existing controls and documentation to identify gaps
- Designing controls that better reflect current operations
- Coordinating with external auditors throughout testing
Outsourced finance leaders can also provide specialized audit experience without the long-term cost of a full-time executive. That flexibility makes it easier to strengthen your control environment without undermining growth.
This is especially important because audit fees often represent a significant capital investment on their own. For example, according to the Financial Education & Research Foundation’s 16th Annual Audit Fee Survey, the median audit fee for an S&P 500 company is $7.96 million.
Internal Audit Assurance With Paro
Steadily progressing toward external audit readiness is an important aspect of scaling responsibly. One of the most effective tactics is to implement an internal audit function early and use it to pressure-test your control environment as you expand.
Paro connects growing companies with audit and assurance professionals who can help you prepare for and navigate the external audit process.
FAQs
Internal audit and assurance is the process of evaluating a company’s risk management and operational efficiency, often including regulatory compliance and internal controls. Its purpose is to identify opportunities for improvement and help leaders manage the business effectively.
Internal and external audits both involve evaluating aspects of a company’s risk management, especially its financial reporting and control environment. However, internal audits aim to help management identify and address weaknesses, while external audits provide assurance to lenders, investors and other stakeholders.
Companies often conduct their first internal audit when they anticipate external scrutiny due to an upcoming fundraising round or M&A transaction. However, it’s often beneficial to implement an internal audit process soon after you start formalizing controls. This allows you to pressure-test your policies, procedures and documentation in advance so you’re not scrambling to prepare for an external audit under a deadline.
