What Exactly is an Audit and How Does it Work?

An audit is an examination of a business’s financial reports by an independent auditor or organization.

The main purpose of an audit is to ensure the information included in the financial reports is true and reflects the company’s financial position at a given date. So, an audit is not necessarily bad for your business; it can also be a maintenance check that lets you know everything is in order with your reporting system. 

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Audits are usually required for listed companies and limited liability companies, but businesses can also request one, depending on their structure, ownership, and plans for future development and collaborations.

So, if you think your business may need an audit in the near future, it helps to learn a bit about the process and how to prepare for it. 

What Happens During an Audit?

As we already established, the purpose of an audit is to ensure that your business’s financial records are accurate and reflect reality. 

For this, an auditor will review your financial statements and accounting books to ensure your income and expenses are up-to-date. This way, if there are any errors (which do happen) or your business has any problems in this department, an audit will point those out. 

While these usually come with penalties, there’s also a silver lining since errors in calculating your business’s revenue and expenses often lead to decision-making mistakes, which can prove fatal for your small business. 

At the end of the audit, you’ll get an audit report detailing what the auditors found.

Auditing of Public Companies

A public company, or a publicly traded company, is usually a large corporation owned by its public shareholders. Considering what’s at stake in this case, public companies must be audited each year (by law), and the audit report must be included in the company’s annual report, which is made available to the public.

This way, the audit report becomes an important tool for investors, who can use it to make informed decisions about whether to invest in a company or not. 

Moreover, public companies are not audited just by any auditor or organization that has the availability. According to big4accountingfirms.org, all US public companies that go through an audit will be checked by one of the Big 4 accounting firms (Deloitte, PwC, Ernst & Young, and KPMG). This adds weight to the audit report as investors trust the Big 4 to do a thorough job. 

Auditing of Small Businesses

Now, whenever small business owners hear the word audit, the one conducted by the IRS is the first one that comes to mind. However, small business audits can be of several types, such as internal, external, and the much dreaded IRS. 

Internal Audits

An internal audit is a great way to check up on how your business is doing, from finances to operations.

This type of audit is conducted by someone within your business and can be used to prevent financial mistakes, update board members or shareholders, and make sure everything is running smoothly. 

External Audits

This type of audit is conducted by an external, third-party auditor, and its main purpose is an in-depth review of a business’s financial records and operations.

The audit follows generally accepted auditing standards (GAAS) and is used to provide an unbiased assessment of a company’s financial and operational performance. At the end of the audit, the auditor prepares a report that is used to inform the business’s financial decisions.

IRS Audits

The IRS usually takes an interest in your small business if there is a discrepancy on your tax return, but you may also be randomly selected. Regardless of the situation, it’s important to be calm, cooperative, and know what to do and what not to do during an audit.

Key Takeaway

While an audit can be nerve-wracking for a small business owner, it is not as scary as you may first think. Do your research, make sure your reporting systems are up to date, and if the chance occurs, take it as an opportunity to learn more about your business practices.