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Finance glossary

What is a financial audit?

Bristol James
6 Min

Financial audits are used to assess the accuracy and transparency of financial transactions for an individual or business entity. Though tax audits and business audits don’t look exactly the same, they share many of the same goals. At the core of any financial audit, the auditors are trying to find accounting errors or recording issues that misrepresent financial transactions within a given period.

Business audits are conducted by an internal audit team or by an external Certified Public Accounting firm. Tax audits, on the other hand, are conducted by the tax authority for your country’s government. As auditors rely on the financial audit process to comb through financial statements, they are highlighting discrepancies, developing resolution plans, and helping business leaders mitigate any future audit risks.

Why are financial audits performed?

Getting a clear picture of a business’s – or individual’s – financial standing is crucial. When the government conducts an audit on a household, they’re working to ensure that the head of that household accurately reported their income to the government and paid the right amount of taxes. For businesses, tax audits and corporate financial audits are a more regular occurrence.

Nearly all businesses receive yearly financial statement audits and tax audits. Over time, more stringent audit regulations for publicly traded companies have been put in place worldwide. There are both national and international financial standards that companies must follow, and regular audits help hold business leaders accountable in the long run.

Financial audit reports are also one of the last lines of defense when it comes to catching and correcting accounting errors. Not all bad accounting is meant to be malicious or fraudulent; sometimes even the best accountants make mistakes. With a robust financial audit process, businesses can adapt processes or rehabilitate gaps in their accounting approach.

Types of Financial Audits

Financial auditing has many different use cases. Businesses and individuals are audited differently from one another, requiring a clear understanding of the types of financial audits that exist today.

Internal Audits

Most large corporations have an internal audit team that is in charge of moving around to different business units, working through the audit process, and completing a financial audit report. At the end of the financial audit process, the internal audit team will issue audit opinions and remediation plans for the team or business unit that is being audited. Internal audits help catch and correct accounting errors, improve internal controls and ensure financial reporting compliance.

External Audits

Bringing in an external auditor allows for candid and bias-free audit reporting. Depending on the size of the business, external auditors may come from a small CPA firm or a larger firm like Deloitte or PWC. External audit reports are submitted to the company’s shareholders, and, if glaring accounting issues are found, the proper legal agency or governing body that oversees the business.

Tax Audits

A tax audit is a method of investigating individuals or businesses to verify that they have reported their true income and paid the necessary taxes associated with that. Tax audits don’t happen every year, in fact, many people and businesses never see one. They are notorious for being complex and detailed, so it’s best to take a look at your financial statements – whether you are an individual or business leader – and ensure everything is accurate.

 

Components of financial audits

  1. Review of documents

Financial audits will happen in multiple parts. First, the business being audited will need to gather a set of documents. The documents needed will be defined by the auditor; usually, the document list is extensive, but it can vary depending on exactly what the audit team wants to look for.

You may be required to scan and upload all documents into a document management system, or simply send copies to the auditor. At that point, they’ll review all the financial statements and related documents to ensure that everything is there. Sometimes the hardest part of a financial audit is finding that one invoice that seems to have gone missing or figuring out why the accountant stored a file in an obscure cabinet.

  1. Financial statements

 

After verifying that all documents have been received, the auditor’s fun begins. They’ll work through each financial statement, audit them one by one, and use their own checks and balances process to ensure that all financial statements are accurate. The financial statements that will be reviewed for businesses are the cash flow statement, income statement and balance sheet, along with any supporting documentation for transactions on these statements.

Assessing Internal Controls

Internal controls are set by accounting leaders within an organization. Corporate governance standards and accounting controls must be put into place to safeguard against unethical or false financial reporting. Internal control systems may look different from one another, but audits can help highlight any gaps in the system and make internal controls airtight. Businesses should be assessing key internal controls on their own, but financial audits add another layer of security to these key business processes.

Benefits of Financial Audits

Financial audits are often associated with headaches, long meetings, and disorganized file cabinets, and while that’s not entirely untrue, there is a lot more to them. Having more sets of eyes conducting financial statement audits is a surefire way to identify accounting errors before they become major issues, increase financial transparency internally, and become an example for the businesses you partner with. The top benefits of financial audits are:

Increased Credibility

Your accounting team has nothing to hide, of course, but the added credibility that comes with clean audit reports and issue-free audit opinions can help establish an additional level of credibility throughout the organization. When sales teams, marketing professionals, and business stakeholders know that they can trust your accounting processes and internal controls, they’ll feel more confident in your company’s ability to succeed.

Identifying Risk

Errors and small financial risks usually only become big issues if they are ignored or overlooked. The financial auditing process was designed to find accounting and reporting errors, track down their root cause, and prevent them from happening again. By weeding out small risks periodically, internal and external audits alike lead to reduced financial risk for your business.

Improved Efficiency

Your accounting team has to run like a well-oiled machine. It’s important that they don’t miss reporting deadlines or omit critical financial information in certain reports. Audits help remove errors and prevent them from happening in the future, cutting back on the time your team has to spend on fixing incorrect numbers or adjusting a journal entry process that has been making the GL impossible to tie out for the last six months. When you remove many small roadblocks – which is what the audit process does – you increase efficiency throughout the accounting function.

Why Should Financial Audits Matter to You?

Financial audits are a safeguard, but they can also have legal implications for businesses. If a business is found to be misrepresenting financial statements, sending fraudulent payments, or expensing items that aren’t eligible to be expensed, that business could face regulatory fines, or worse, be forced to shut its doors. Anyone who works in a company should care about financial audits because they result in transparency, financial security and better internal financial controls. Whether you are a leader at the top or an intern for the summer, financial auditing can mean the difference between a long-lasting career and a crumbling employer.

On an individual level, nothing comes around faster than tax season. After all individuals and businesses submit their yearly tax returns, the government goes through all submissions and looks for any that seem inaccurate. From there, they’ll launch investigations. If an individual is found to have misreported their tax income, they’ll need to pay additional taxes. For businesses, the same is true. If more serious findings come out, tax audits could result in legal penalties as well.

Summary

  • Financial audits are a mechanism used to examine financial statements for businesses or individuals, highlight any gaps or errors, and mediate those issues moving forward.
  • An audit can take multiple forms. The three main types of audits are internal, external and tax audits. Internal and external audits are used only for businesses, but a tax audit can happen in personal and professional settings.
  • If you aren’t conducting internal audits within your business, consider setting up the infrastructure to do so. Internal audits have less serious implications than external audits and can give your organization the chance to improve prior to an external audit.
  • Audits, as time-consuming as they can feel, are full of benefits. Instead of looking at them as something that’s meant to “catch you in the wrong,” look at them as a tool that can increase credibility, highlight risk, and improve efficiency. We can’t get better without knowing what we’re doing wrong; audits are an important part of pinpointing the root cause of financial issues.

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