A successful, privately held small business may ask a banker, investor, creditor, or buyer for an audited financial statement. These third parties often want some assurance that the financial statements provided by your business are reasonably accurate and free of any significant oversights or material errors. Similarly, a compilation may be helpful for you right now, but third parties, such as banks, may want greater assurance. The following insights into the differences between audits, reviews, and compilations may help you better understand why they can be helpful for you and your business.
Audits provide the highest level of assurance to the user of the financial statements. Some companies report that providing banks with audited financial statements has resulted in lower interest rates than companies without audited statements. Of course, not all banks require an audit. A review provides less assurance and generally costs less than an audit. In many circumstances, a review provides enough assurance to the user of the financial statements, and an audit is unnecessary.
The American Institute of CPAs explains that compilations are “intended for use by lenders and other outside parties who may appreciate the business’s association with a CPA without requiring a level of assurance on the accuracy of financial statements.” A review, however, is “intended to provide lenders and other outside parties with a basic level of assurance on the accuracy of financial statements.” It may be necessary when you’re seeking extensive financing.
Consider the Differences
- Audit: This provides the most assurance. An audit entails understanding internal controls, outside verification of selected items, and many other detailed procedures that allow an accounting firm to render an opinion on the financial statements.
- Review: This provides some assurance. It is the most common form of assurance of financial statement accuracy for small businesses. It’s not an audit — it is much less extensive and provides limited assurance that financial statements are basically in conformity with generally accepted accounting principles (GAAP).
- Compilation: A compilation entails obtaining information internally and placing it in financial statements, without expressing an opinion or assurance.
A review is more thorough than a compilation. It is considered the base level of CPA assurance services. Your CPA must understand your industry’s accounting principles and practices in a review engagement. An accountant obtains knowledge about you, your business, and the accounting principles and practices. This identifies areas where material misstatements may arise.
In a review, a CPA performs analytical procedures and inquiries to obtain limited assurance about financial statements intended to provide a user with comfort about their accuracy. It’s substantially narrower in scope than an audit, but it may still suit your purposes.
Most experts agree it’s insufficient to rely on your banker’s interpretation of your internal financials. Some level of assurance is a good idea…and quite possibly a requirement at any lending institution. Ask if the bank requires or recommends an audit — it may be worth the money.
Getting Outside Funding
A common question is whether there’s a need for audited statements when you’re seeking cash from outside sources, such as a venture capital or private equity group. The answer is generally yes. A lot may depend on what stage the company is in. An early-stage company may not need an audit or review, because possible investors are more concerned with your company’s potential. However, if it’s a more established company, and it’s relying on its history as an essential basis for seeking funding, then it may have to show audited statements.
No matter what the investor group requires upfront, you can expect that it will require audits in the future as part of the terms of its investment.
Similarly, if you’re at a later stage in your company’s life — for example, seeking to be acquired as part of a retirement plan — you’ll need audited financial statements to show any potential suitors, even if you’re privately held.
You may have questions about whether an audit, a review, or a compilation would suit your business. Call your Vrakas CPAs + Advisors team to discuss your business and situation, and we’ll help you make the right decision.