Finance glossary

What is an external audit?

Bristol James
4 Min

An external audit is an assessment of the accuracy of your financial statements by an independent third party. Independent examination gives lenders, shareholders, and regulators assurance that your financial statements are free from material misstatements. For example, if your bookkeeper forgot to record a large transaction, that omission could have a serious impact on the results of your operations.

Moreover, external audits also confirm that your company is compliant with applicable accounting standards and financial regulations, like International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). An external auditor will issue an audit opinion on the accuracy of your financial statements and the effectiveness of your internal controls.

Having an independent examination of the financial records and controls of your company gives confidence to third parties, which can help your organization unlock new capital and funding. Not to mention that transparency in your accounting records is helpful to make informed business decisions.

Differentiating Between Internal Audits and External Audits

Internal and external audits have similar objectives, but different processes. An internal audit will focus on the internal controls and systems your organization has in place. For example, your internal audit function might collaborate with different management teams to review the validity of transactions. Both tangible and intangible objectives are evaluated by internal auditors, like finances, IT, culture, and ethics.

On the contrary, external auditors are independent third parties, like a CPA firm or an auditor registered with ASIC. These professionals offer an independent examination of your accounting policies and financial statement accuracy according to professional standards. External audit work will also dive into the fraud prevention controls your business has in place and how well your business complies with regulations.

How Frequently Should an External Audit be Performed?

The external audit process is very detailed, meaning it can take anywhere from a few weeks to multiple months before the audit firm can issue a formal report. As a result, most companies perform external audits on an annual basis. Issuing a formal annual report is generally sufficient for lenders, investors, and other third parties.

However, some large companies benefit from more frequent external audits. For example, public companies listed on national exchanges need to submit quarterly financials. Having an independent firm review the accuracy of these statements can be beneficial. More frequent external audits also help your company with effective risk management.

Even if you choose to limit your external audits to once a fiscal year, you can still conduct internal audits throughout the year. Reviewing internal control policies with your audit committee and investing in expense management software helps detect mistakes and errors before you have a formal audit. This can improve your chances of receiving a clean audit opinion from audit firms, maintain compliance with regulatory agencies, and shed insights into the financial health of your organization.

The Benefits of External Audits

External audits verify the accuracy of your accounting transactions. Let’s cover some of the benefits of regular external audits:

  • Improved Credibility – External audits verify the authenticity of your financial statements, increasing credibility, transparency, and confidence in your business.
  • Reduced Mistakes – Mistakes can easily go undetected without a fresh set of eyes. External audits identify and correct financial statement misstatements.
  • Regulatory Compliance – Audits test compliance with regulatory agencies, which leads to the reduction of fines, penalties, sanctions, and scandals.
  • Further Education – Having an auditor explain changes is beneficial for your team, leading to compliance improvements going forward.
  • Objective Insights – An external audit solidifies your financial statements, giving you objectivity when it comes to making informed decisions surrounding growth.
  • Support Expansion – Potential shareholders and lenders will request verified financial statements. Having a routine external audit helps you raise additional capital and expand with ease.
  • Fraud Detection – Fraud can happen to any small business, regardless of size. Using an external auditor helps you uncover and prevent asset misappropriation and fraud.

External audits can be costly depending on the scope of work. Nevertheless, having an annual external audit can be a great way to leverage these benefits.

Summary

  • An external audit is an assessment of your financial statements for misstatements, fraud, and effective internal controls by an independent third party.
  • An internal audit is an informal review of your procedures, processes, and financials from staff within your company.
  • Most companies have annual external audits. Some large companies are required to have an external audit to be listed on national stock exchanges.
  • External audits help your business improve credibility, comply with regulatory agencies, expand into new markets, and detect fraud.

 

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