A financial statement audit can be considered a “health check” for a business’s finances. Through this process, the auditor will review the financial statements to ensure all listed figures reflect the actual situation and then report the results. Armed with accurate reports, as a business owner, you can make more confident decisions, and external parties, such as investors or creditors, will have greater confidence in your business. So, read this article to the end!
What is a Financial Statement Audit?
According to Oracle NetSuite, a financial statement audit is an examination of a company’s financial statements by a professional to determine whether they present a fair and materially correct picture of the business’s activities and financial position.
This process usually refers to the Generally Accepted Accounting Principles (GAAP) standards issued by the Financial Accounting Standards Board.
According to AuditBoard, audits can be conducted by either internal or external auditors. However, external auditors are considered to have a higher level of objectivity and independence. They typically provide a more independent opinion on their audit results.
Types of Audited Financial Statements
Financial statement audits generally focus on three primary statements: the balance sheet, the income statement, and the cash flow statement. However, some also examine the statement of changes in equity, while reviewing the internal control system for financial reporting. Each statement has a specific function, but they provide the most complete picture when read together.
1. Balance Sheet
The balance sheet shows a company’s financial position at a specific point in time—for example, at the end of a month, quarter, or fiscal year. This document lists the company’s assets, liabilities, and equity. Auditors will review the balance sheet to ensure that the assets and liabilities are presented correctly and are free from errors, thus reflecting the true financial condition.
2. Income Statement
This report describes a company’s performance over a specific period by detailing revenues, expenses, profits, and losses. The final section of the report displays the bottom line, which is net profit or net loss. For public companies, earnings per share (EPS) information may also be included. During the process, the auditor will trace transactions through the cash book and general ledger to ensure that revenue and expense figures have been recorded accurately.
3. Cash Flow Statement
The cash flow statement shows the inflows and outflows of cash during the reporting period, grouped into three categories: operating, financing, and investing activities. This document helps assess a company’s ability to meet short-term obligations and maintain business continuity. Auditors typically reconcile cash flow data with bank statements and check the accuracy of footnotes to ensure transparency.
4. Statement of Shareholder Equity
While it can be integrated into the balance sheet, this statement is sometimes prepared separately to show changes in shareholders’ equity over a specific period. This information is useful for investors in assessing the company’s growth and making decisions, such as increasing ownership when equity increases or disposing of shares if their value decreases.
5. Internal Control over Financial Reporting
In addition to examining primary reports, an audit may also include an evaluation of the internal control systems that govern the recording, processing, and reporting of financial data. The goal is to ensure that internal processes are capable of preventing and detecting errors or fraud, ensuring that the information produced remains accurate and reliable.
Benefits of Financial Statement Audits
Financial report audits provide many important benefits for business actors, including:
1. Ensure Data Accuracy and Reliability
Audits help ensure that financial records fairly and accurately reflect business transactions and performance and provide reasonable assurance regarding future business prospects. This is important because investors, creditors, and business partners often rely on financial statements for decision-making.
2. Prevent Fraud
The audit process can identify potential fraud or irregularities in financial records, thereby helping to maintain business integrity.
3. Comply with Regulations
Some types of businesses, particularly those overseen by regulators or participating in large tenders, are required to have audited financial statements to meet legal or administrative requirements.
4. Increase Stakeholder Trust
Financial institutions typically request audited financial statements when applying for loans. A good audit provides lenders with confidence that the business is managed soundly and professionally.
5. Operational Improvements
Audit results often reveal inefficiencies in business processes, allowing business owners to make improvements and boost financial performance.
Financial Statement Audit Steps
In general, a financial statement audit is conducted through several sequential stages. By understanding this process, you can prepare yourself so that the audit runs smoothly and without any significant obstacles.
1. Planning and Risk Assessment
The initial stage begins when the auditor is appointed, and a formal engagement letter is drawn up. The auditor will form a team, ensure there are no conflicts of interest, and create an audit schedule.
At this stage, the auditor will also study the business, industry, and applicable regulations, and assess areas most prone to errors or fraud. The result will be an audit plan that will guide the next phase.
2. Internal Control Testing
The auditor will begin by assessing the systems and procedures the business uses to prevent errors or fraud. These include, for example, segregation of duties among staff, restricted access to accounting systems, and physical inventory checks.
If internal controls are strong, the audit process can be faster. Conversely, if weaknesses are discovered, the auditor will conduct a more detailed data review at a later stage.
3. Substantive Testing
This stage focuses on verifying the accuracy of the data in the financial statements. Auditors typically sample transactions, examine supporting evidence such as invoices, bank or supplier confirmations, and even directly inspect physical assets such as inventory or equipment.
In some cases, auditors may also need to perform data analysis or recalculations, such as on depreciation or loss reserves.
4. Preparation of Financial Reports
Based on the audit results, the auditor will assist in refining the financial statements (if necessary). However, full responsibility for the report’s content remains with management.
The process of preparing this report is usually accompanied by intense communication between the auditor and management so that important findings can be discussed and corrected before the official opinion is issued.
5. Providing Audit Opinions
The final stage is for the auditor to issue a formal opinion, which will be attached to the financial statements. The type of opinion provided may include:
- Unqualified opinion: financial reports are deemed accurate and meet standards.
- Qualified opinion: there are certain parts that are less appropriate, but overall the report remains reliable.
- Unqualified Opinion with Explanatory Paragraph (modified unqualified opinion): basically states that the financial statements are fair, but the auditor adds an explanatory paragraph related to certain conditions or events, for example litigation uncertainty, changes in accounting methods, or dependence on certain parties.
- Adverse opinion: financial reports are considered not to meet standards and do not reflect actual conditions.
- Disclaimer of opinion: the auditor is unable to provide an opinion due to limited data or access.
Financial statement audits are not only crucial, but also a strategic step that helps businesses run healthily, transparently, and prepare for faster growth. Start managing your business finances more easily and structured with Labamu’s best features. Everything you need is in one app!
