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Startup Financial Audits: Why, When, and How

Having anyone with the title of “auditor” poke into your startup’s finances is a scenario that instills fear and terror in the hearts and minds of many entrepreneurs. And yet, getting an audit is a practical and effective way for startups to review their financial books and make sure the business is compliant with accounting standards. It can also give peace of mind to jittery investors as many startups are run by entrepreneurs not intimately familiar with the accounting practices and methodologies required to produce compliant financial statements and reports.

An audit can find and fix these problems, pre-empting any tax or legal issues down the road. Yes, audits by a third-party vendor can be very nerve-racking, but if you want your business to avoid lawsuits or accusations of fraud and negligence, you will be grateful for them in the long-term. And some investors require them as part of their investments, so avoiding them could prevent your startup from obtaining much-needed cash as it grows.

Unfortunately, compiling the materials required for an audit can be a cumbersome procedure if you’re not prepared. So, in addition to giving you the background on when and why a startup company might need a financial audit, we’ve compiled a list of helpful tips for keeping your financial records in audit-ready order.

 

Financial planning for startups: Let’s answer why first:

An audit can give founders a good overview of how their finances are being managed—the pros and the cons. We suggest that startups only contemplate having an audit when they’re generating significant revenues — to do it before that would probably be a sub-optimal use of scarce cash.

This leads to the next question: What circumstances would necessitate an audit?

  • Your investors are calling for it. Series B or C investors usually require it, sometimes even Series A rounds call for it too;
  • The bank in which you’ve applied for a line of credit is requiring assurance of your financial statements and records;
  • You are planning in the future to sell your business and are mindful that many buyers won’t consider acquiring your operations unless you have several years of audits under your belt;
  • You’re planning to take your company public; and,
  • Your board wants to ensure that your financial statements are accurate and have met financial expectations. They might suspect errors or deficiencies in the accounting.

Great. So what documentation do you need to provide to the auditor?

  • Your trial balances and all supporting documentation for the year in question (and sometimes the year prior so they can get comfortable with opening balances)
  • Material contracts;
  • Employment agreements;
  • All documents related to equity and debt financings;
  • Incorporation documents
  • Supporting records such as shipping/tracking numbers, payroll records, tax returns, and anything else related to the business’ finances.

It cannot be stressed enough that your startup’s accounting team must ensure that all historical balance sheet schedules are maintained, that all supporting documents be retained, and that everything is organized so as to be easily found & accessed.

Make sure all of your records are accurate and up-to-date. This type of financial planning for startups is integral to your company, whether you’re preparing for an audit or not.

 

Meeting with the auditor

Preparation and communication are two keys to a successful audit. First steps are kickoff meetings with the audit team. To help facilitate this process (and keep any anxiety at bay), ask the auditors how they will conduct the audit. This will give you a clear understanding of what to expect.

In addition to providing the auditors with the required documents, you should also get clarity about deadlines: When do the auditors need what, when will they be in the office, when should you expect draft and final audit reports, etc.

Also, bear in mind that because an audit is a time-consuming, detail-driven procedure, the audit team will most likely need your full time and attention during the first week of the audit. If your business is working on a project in which you have an active role, then you will need to temporarily delegate until the auditors no longer require your attention.

Also, when the audit team visits your workplace, introduce them to your staff. Make sure your employees are aware of the audit team’s presence, the reason they are there and why your attention will be a focus on working with them during the initial stages of the audit.

In addition to reviewing your financial and accounting records, an audit may also check your startup’s cybersecurity policies to make sure you’re providing satisfactory protection from theft and fraud. Do you have internal control safeguards in place that include having different employees handle specific accounting duties? Or password protected accounting software that tracks exactly who does what and when?

Another component of the audit is comparing internal records of cash flow, income, and expenses against external records. Here the auditor will compare receipts from suppliers for a certain period against the internal records or compare the cash flow records against the revenue recorded on the books.

 

Preparing for an audit

In addition to having your documents professionally prepared, make sure they’re well organized and easy to navigate. This will quicken the audit procedure, making it as painless as possible. When storing your documents, use a secure virtual data room, like the cloud or Dropbox. This data should be readily available and accessible. And this applies to whether you’re near to having an audit or not. Having solid financial records for all of your transactions, even those that don’t affect your cash flow and the balance sheet is not just simple business savvy but the key to your startup’s success. All this audit prep work are critical elements of financial planning for startups.

Before you reach for the Xanax, remember that a financial audit does not have to induce a full-on panic attack. Rather, if you follow the tips we’ve outlined, stay organized and have gathered a qualified team of financial and accounting professionals to help you with your reporting, the procedure should be smooth and migraine-free. Granted, it’s not fun; however, a financial audit is a great way to validate your records while providing a clear and comprehensive oversight of how your business is being managed financially. Relax!