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MBA Mondays: Financial audits

On Mondays, sometimes I like to discuss business topics when I have the chance.

MBA Mondays is an idea I got from Fred Wilson.  The issue this Monday is financial audits. I have been thinking about audits recently, since we spend a lot of time going through them for deals that we work on.

See below for a few short tidbits on a financial audit.

What? A financial audit is an audit of a financial statement.  An audit means the verification of the accuracy (e.g. truth) and reasonableness of the financial statements.  The audits usually (but not always) result in an opinion band the opinion is intended to assure various parties that the financial statements are fair and that they give a fair view of the company based upon the accounting standards.

Are they a guarantee? No. An audit is intended to provide reasonable assurance, but it does not give a guarantee.

Who? Audits are usually done by audit firms. These are firms with licensed accountants who are experts in the field. They are almost always independent third parties.

Why? An audit (and the opinion) is intended to assure various parties that the financial statements are true and reasonable.  More specifically, it is intended to ensure that the company is not doing anything that is materially misleading its filings. This is why it is done by an independent third party.

Why does it matter?  These can be important in transactional work. In any sort of transaction, one company usually needs to be valued, because it is being sold or acquired, or its stock is being sold or acquired.  In order to value a company, a buyer and seller should understand things like assets and liabilities, cash and cash equivalents, property and equipment, and the short and long term debt of the company, among other things. Financial statements presented by the company have these numbers, thus the financial audit are important to help prove that the numbers the company gave are reasonably correct.

Layman’s Terms:  Think about it like your tax return.  You could purposefully put misleading information in to save money ever year. Moreover, even if you try to get it right, you may accidentally still get things wrong or mislead the readers. In many cases, the government will do an audit, to make sure what you submitted is correct.  That’s why tax firms will often audit the forms first, to make sure everything passes the test of reasonableness.

Keep in mind that this is the short version. The audits can become quite a bit more complicated than this.

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