What Happens Behind the Scary Scenes of the Financial Audit Process?

What Happens Behind the Scary Scenes of the Financial Audit Process?

discover | Sunday - 26 / 05 / 2024 - 9:11 pm

The financial audit process has a bad reputation as some people assume it’s a complex process that can take months! But, assuming your records are clear and up-to-date, it will be easier than you think. Let’s tell you what to expect during the financial audit process and how to prepare best.

Defining Financial Audit:

A financial audit is a comprehensive examination conducted by an auditor of a company’s financial data to verify the accuracy and fairness of the organization, individual, or management’s financial affairs.

Financial audits can be conducted internally; to assess the financial status of the department/branch in general, to identify any risks to your financial resources, and to identify where improvements can be made (if any improvement found). However, in general, financial audits are carried out by external auditors in four stages:

1. Preparation Phase for Financial Audit:

The preparation phase for a financial audit consists of the following steps:

• Preparation of financial data and related documents:

In the era of digital transformation, you are expected to digitize your records (i.e., create and store records through computer systems rather than manually). Digitizing of records makes the financial audit process much faster and easier. For example, Logix ERP system for human resources management includes a payroll feature that allows you to extract payroll reports, tax calculations, and more at the click of a button (which saves you hours of searching through papers during the audit process).

• Communicate with the financial auditor:

If you are able to work with the auditor, the financial audit process will be smoother and more satisfying for all parties. Maintain clear and open communication with the auditor, and make sure everyone is aware of what will happen and when it will happen.

• Schedule a date and time for the audit:

Depending on the circumstances of the financial audit, you should be given a reasonable timeframe to gather your financial data and other audit-related documents. Work with the auditor to determine a date that gives you enough time to prepare and also allows the auditor to do the job in a timely manner.

2. Planning Phase for Financial Audit:

This phase involves the following steps:

• Understanding the Audit Scope:

Here, the importance of communication with the auditor is highlighted. The auditor should:

– Explain the scope of the audit.

– Identify the types of financial data he/she is looking for.

– Clarify the form of procedures to be taken after identifying risks and controls.

– Explain what is expected regarding documentation and cooperation.

Ensure you have a clear understanding of what the financial auditor is telling you about the scope and objectives of the financial audit. If you do not understand something, do not hesitate to ask the auditor. I would like to emphasize here that the financial auditor wants to work with you, not against you. It is in his/her best interest that you understand the audit process and participate fully in it.

• Identifying Risks and Controls:

Financial audits are typically accompanied by several risks, including:

– Inherent risks: These include the basic risks associated with subjecting financial data and accounts to audit.

– Control risks: These include financial errors resulting from the lack of adequate controls in the accounting process.

– Detection risks: These involve the failure of auditors to notice something they should have noticed.

During the planning phase, the financial auditor will attempt to determine the level of “risk”. This includes verifying the controls within your accounting system and the complexity of your accounts (increased complexity means increased detection risk). If any risk is considered too high, the auditor will implement controls to mitigate the risk. This may include increasing the audit sample size, implementing cyber security measures, or focusing on specific documents.

3. Actual Financial Audit Process:

The actual financial audit process consists of the following steps:

• Gathering Evidence and Documentation:

During the financial auditor’s review of documents and evidence, he/she may find that they need to request additional information (perhaps to strengthen or support the documentation provided). For this reason, it is a good idea to organize all of your documents in the preparation phase so that they are easily accessible. Alternatively, you can adopt the best option, which is to use an ERP system with all its data centralization capabilities.

• Testing of Internal Controls and Transaction Cycles:

Financial auditors may employ various methods, including:

– Inquiry: The auditor questions your employees about the controls they use to ensure the accuracy and reliability of transactions.

– In-person observation: Here, the auditor observes the daily work routine of the management or branch to understand how transactions are executed and controls are applied.

– Testing: The auditor will use documents and records to test how controls are implemented and their effectiveness.

– Reperformance: This involves the financial auditor attempting to execute controls and transactions themselves to verify their effectiveness.

Professional financial auditors also utilize Computer-Assisted Audit Tools (CAAT) to analyze your digital systems and controls.

• Financial Data Analysis and Interpretation:

After reviewing your data, the financial auditor will analyze and interpret it using six primary methods:

– Identifying Industry Economic Standards: The industry you operate in significantly impacts your finances and how they are handled. The financial auditor utilizes industry standards to ensure he/ she conducts a fair analysis.

– Determining Company Strategies: The auditor delves into company specifics, such as the nature of your product and profit margins. This could extend to all aspects of your operations. For instance, you might use human resource management software to analyze HR and hiring expenses. This data can be compared to your financial records to identify any discrepancies.

– Assessing the Quality of Your Financial Data: The aim is to determine whether your financial data accurately reflects the company’s financial health.

– Profitability and Risk Analysis: This could involve examining liquidity ratios, asset management, debt management, profitability, and market assessment.

– Using Analysis to Prepare Projected Financial Statements: At this stage, the auditor will attempt to forecast future financial data based on the provided information.

– Company Valuation: The financial auditor will utilize the provided data to conduct an approximate valuation of the company.

This thorough analysis and interpretation by the auditor enables a comprehensive understanding of the company’s financial position, its approach to financial management, and any discrepancies between projected and actual financial performance.

4. Reporting Phase:

This phase consists of the following steps:

• Preliminary Draft of the Auditor’s Report:

Upon completion of the analysis, the auditor will draft an initial version of their report. This version typically includes three main sections:

– Scope and Purpose Statement.

– Main Body of the Report including a statement of facts and findings.

– Conclusions and Recommendations.

• Disclosure of Findings and Recommendations:

In this stage, the auditor shares the aforementioned information with decision-makers before finalizing the report.

Sometimes, implementing some of the auditor’s recommendations may not be practical, such as in the case of internal audits. Similarly, decision-makers may feel that some of the auditor’s findings may be unfair, perhaps because the auditor did not fully understand a particular aspect.

• Finalizing of the Audit Report:

Following discussions with decision-makers, the auditor will prepare a final version of the report. The final report will include details of the audit process, its scope, findings, improvement and recommendations. The auditor will present the final report to the decision-makers.

Key decision-makers will sign it as evidence of their approval of the report’s contents.

Finally, the company, department, or branch will be notified of the need to implement the financial audit recommendations.

Are You Ready for a Financial Audit?

Financial audits are a routine procedure for companies of public sector, but even if your company is private, it is advisable to have your financial statements reviewed annually. This demonstrates to investors and shareholders that your company is trustworthy and worth their investment.

If you are considering having your financial statements audited, everything starts with choosing the right financial management system. After that, all you need to do is prepare your financial statements for review and wait for the audit opinion letter. This way, the next time you are considering starting a new funding round, you will have more than just your word to back you up.