A financial audit involves a careful examination and analysis of an individual’s or an organization’s documents and records of receivables, payables, transactions and other business areas pertinent to the entity’s financial activity.” It is conducted by an independent external party, usually a CPA or an auditing firm. One of the objectives of the audit is to check whether the financial statements are accurate, complete, and truthful. Although audits are usually performed for large corporations, small businesses, non-profit organizations, and even individuals seeking to understand their financial options, also require them.
This post will discuss what a financial audit includes, the various types of audits, and why it is essential to have your finances audited.
What Is Provided in a Financial Audit?
A financial audit is a holistic examination of the financial statements of any company and its associated business and accounting records. The objective is to ensure that the set of financial statements is neither overstated or understated, but adequately reflects the financial situation of the entity under appropriate accounting frameworks like GAAP and IFRS.
Here is a short overview of the main parts of a financial audit:
- Examination of financial records: The examination of financial documents includes balance sheets, income statements, tax documents, banking records, receipts, and invoices. The auditor confirms that every piece of financial documentation has been prepared and is complete.
- Verification of transactions: Each transaction is verified by ensuring that expenses, income, and all financial commitments are properly recorded in the books.
- Testing of internal controls: Auditors sometimes review other processes in a company and the controls that the company has in place like cash flow management and account payable and receivable management, and company compliance with laws and regulations.
- Evaluation of compliance: An audit includes looking to see if at all the entity is following the applicable laws such as taxation, labor laws, and standards relevant to the industry.
Once the audit is complete, the auditor is obligated to issue an audit report in which they describe the outcomes of the audit work done. Depending on the outcome, the report will express some opinion on the truthfulness of the information in the financial statement. Types of report include:
- Unqualified (clean): From the audit, the entity is assured that its financial statements are materially misstated and does represent the entity’s financial standing.
- Qualified: In this situation the entity is partially correct. Some parts are reasonable without supporting evidence.
- Adverse: The organization’s financial statements are significantly inaccurate, and the auditor thinks that they do not represent the entity’s financial standing appropriately.
- Disclaimer: The auditor had no sufficient information that would enable them to provide an opinion about the financial statements.
Kinds of Financial Audits
There are different kinds of financial office; each is meant to serve a specific purpose depending on the needs of the person or business. Following are some of the most common types:
- External Audit This is conducted by an independent audit who is not in any way associated with the organization being audited. This kind of audit is common for publicly traded companies because it protects the interest of investors, regulators, and other interested parties by verifying that the company actually prepared its financial statements accurately.
- Internal Audit They are carried out by members of staff of the organization or by an internal audit unit. Though an internal audit is not a legal requirement, it enables organizations to validate that the internal controls are operating as intended and that financial transactions are being processed correctly.
- Forensic Audit Forensic audits are more specialized and are usually done when there is suspicion of fraud, embezzlement or any financial misconduct. These audits require detailed examination of particular transactions or activities to find out if there has been any illegal or unethical wrongdoing.
- Tax Audit A tax audit is done generally by government institutions like the IRS in the USA. They do it to verify whether an individual or an organization is following the tax guidelines and properly reporting their income, expenditure, and deductions.
Why Should You Consider a Financial Audit?
Even though financial audits seem to be an activity for large corporations or public companies, they provide a lot of value to individuals, small businesses and even non-profit organizations. Let us look at some points that highlight the importance of financial audit.
1. Ensure Accuracy and Transparency
A financial audit has lots of advantages but one of the most important ones is the accuracy of financial statements for the entity. If you are an individual or a business person, it is reassuring to know that your financial records are kept in proper order because not doing so can lead to significant issues, both financially and legally, in the future.
For an organization, audits heighten the transparency level by boosting stakeholders’ confidence in its financial state. For instance, investors, employees, and even regulators. Further, precise financial documents are needed in seeking for loans, attracting investors, or even starting the mergers and acquisitions processes.
2. Determine Possible Financial Challenges
Missing major financial concerns can easily be tackled through financial audits. Auditors have the ability to find discrepancies within the accounting system such as missing documents, errors within the system, or even wrongly placed documents. If these issues are tackled as early as possible, corrective measures can be put in place to avert these problems from growing to larger issues such as missed tax payments or expenses that are unaccounted for.
Due to lack of assigned accounting departments, small sized firms suffer the most. Audits have the ability to shine light in areas of inefficiency that being done or potential fraud that is being done which lowers the overall profit of the business.
3. Enhance the Internal Control System
Every procedure within a business has to follow internal controls. Moving cash from or into the organization, paying the organization’s bills, or making any financial decisions. Auditors make it a point to come up with suggestions that reinforce the controls that are already there so that cases of fraud, mismanagement, or mistakes are reduced or better yet, eliminated.
Internal controls form a critical pillar of a business’s operational and financial health. Preventive audits can mitigate errors and potential fraud by identifying gaps in your financial systems.
4. Increase Reliability and Trust
If you are a private individual looking for financial guidance, an organization looking for funding, or a non-profit entity seeking funding, an independent audit will definitely increase your credibility. An independent auditor’s report certifies that an independent professional has verified your financial records, and thus corroborates your claims.
For companies, the audit serves to promote transparency and thus provides shareholders, employees, customers, and even regulators who depend on precise audits with full confidence in the financial statements that the company provides.
5. Compliance with Tax Laws
A financial audit fosters compliance with relevant laws for individuals and businesses alike. Whether it is a tax return or any document that is bound to a return, a financial audit guarantees accuracy and compliance with applicable laws. Errors and omissions in tax filings could result in sanctions, fines, or even criminal prosecution. Therefore, having a financial audit relieves one of burdens that their tax filings are correct.
Furthermore, audits can help lower your tax expenditure because they may reveal unclaimed expenses that could be claimed as tax deductions or credits.#### 6. Strategic Planning and Management Developments
Analyzing financial records has revealed that firms undergo various downsizing processes. Audits tend to identify specific areas where finances can be optimized. Further, an organization trying to cut down its costs, a person planning for retirement, or even a small firm trying to expand can benefit from the financial strategizing that an audit provides. Recommendations that are provided by auditors enable you to work towards optimizing some dynamic strategies which allow you to respond to planned changes in the environment.
Conclusion
The need for a reliable financial audit stems from the requirement that the financial documents shall require strict truthfulness, openness, and adherence to existing laws, rules, and governing documents. Whether you are an individual wanting to ensure your finances are well protected, bank on your financial statements, manage a small business as your self employed or even if you are a big corporation planning to list your shares to public or attract foreign direct investment, financial audit is of essence to you. There are various benefits as they help determine the problems, control them, enhance their credibility, and significantly track their financial targets.
If you question the effectiveness or even the accuracy of your financial management, the best way to resolve it is by undergoing a financial audit.