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October 2, 2020
The prospect of going through a financial audit is daunting, but comes with the territory of running a business, particularly when you raise venture capital to fund your business. In fact, a financial audit is a common requirement as part of the due diligence process for startups raising Series A and later stages of venture capital.
Preparing for an audit can be a time-intensive, stressful process; but it doesn’t have to be. It’s entirely possible to operate your business and manage your finances to be audit ready, meaning you’re always prepared if or when your business is asked to complete an audit.
There are several things startups can do to ensure they are well prepared for a financial audit. This article will outline the different types of financial audits startups may face, the scenarios which may trigger an audit, and outline helpful steps startups can take to ensure their business is audit ready. We’ve also included best practices should a financial audit be requested for your startup.
According to Investopedia, “a financial audit is an objective examination and evaluation of the financial reports or statements of an organization to make sure that the financial records are a fair and accurate representation of the transactions they claim to represent.”
There are three types of financial “audits” a startup may be required to complete:
A compilation requires an external CPA or auditor to compile and present the financial statements (Income Statement or Profit & Loss Statement, Cash Flow Statement and Balance Sheet) requested without any formal verification of the information presented. This is the simplest format of the three types of audits.
A review requires an external CPA or auditor to analyze the financial statements to ensure accuracy, and assure the information being presented does not require any significant updates or changes. It may also include some testing of internal controls and accounting processes. Generally speaking, a review provides a ‘middle-of-the-road’ CPA assurance.
An audit requires an external CPA firm or auditor to confirm accuracy of all the financial information presented, in addition to running tests of internal controls, examining source documents, corroborating with third parties, and more. This is the most extensive, and costly, type of audit that may be required of a startup business, and produces the highest level of CPA assurance for the investors or lenders that requested the audit.
Because startups are private companies they are not required to undergo the annual audit of financial statements required of public companies. That said, there are a number of scenarios that might require a startup to undergo an audit of its finances. These scenarios include:
Whether you’re preparing for your first audit or have been down this path before, below are five important steps you can take to ensure your startup business finances are audit-ready on an ongoing basis:
In order to get through a financial audit unscathed, it’s essential to keep all of your financial records, including receipts for purchases > $75. Before processing payment for any service provided to your business, request an itemized invoice; this applies to all vendor types, and hourly skilled workers of all kinds (developers, marketing professionals, etc.). Establish an email alias such as firstname.lastname@example.org to be used for all financial-related correspondence. This creates a simple channel for capturing important financial documents from across your organization and third-party vendors alike. Use this as your billing email address when making purchases on behalf of the business to ensure all receipts are captured. As a best practice, all receipts and invoices should be attached to the bill in your accounting software or ERP system for support documentation.
How long business owners should hold onto their financial records is often debated. Many business owners decide to store their financial documents indefinitely, choosing an accounting partner like Zeni that leverages the cloud to store your financial records in an organized manner. Startups should keep hold of all accounting records that document your business’ financial history. This will allow you to get through an audit with minimum stress, disruption, or business downtime.
It’s crucial to keep track of all your company’s financial information in a clear, organized manner. If your company’s financial data is riddled with errors or missing important details, it will be a challenge for you to find what you’re looking for when it’s needed. Neglecting to organize your business financials on an ongoing basis will force you and your team to spend a considerable amount of time during the audit revisiting details of past financial interactions -- which is not a good use of any business leaders’ time, nor does it send a positive signal to the external party who requested the audit in the first place.
A few helpful tips for keeping your financial records organized on an ongoing basis include:
This level of detailed organization is standard practice for startups who partner with Zeni to manage their business finances.
At the very least, your bookkeeping or accounting software should be updated and reconciled on a monthly basis. It’s prudent to never put off updating your accounts, or you’ll find that you need to rush to catch up or go through everything again when it’s time to have an audit, or even when you are in discussions with strategic partners, investors, and/or large enterprise customers. Rushing to update your books when a timely request arises results in sloppy mistakes that can cost money and deals.
See also: 8 Best Accounting Tools for Startups
Auditors will use generally accepted accounting principles (GAAP) as the benchmark to evaluate and compare your company’s finances (the same goes for investors, board members, and bankers). If you aren’t following GAAP standards, the audit process will require additional time to restate the financials in order to evaluate your business finances against a common set of standards .
At a minimum, startups should use the accrual-basis accounting method to establish a baseline of GAAP compliance. Many of the GAAP standards are based on accrual accounting best practices, so this is an excellent first step for startups. Another important area to apply GAAP is revenue recognition, which is very industry-specific and can be challenging to properly account for. It is strongly encouraged that startups engage an experienced accountant to ensure this is done properly.
Establishing clear controls and approval workflows allows for proper segregation of duties in an organization. Having these “checks and balances” in place ensures no single person within an organization has the authority to spend money or approve payments to vendors without oversight.
Controls and approval flows can be simple to design and implement. Depending on the compliance requirements of the organization and the types of financial transactions facilitated most regularly, the workflows can be based upon a monetary amount, department, project, category, etc. -- you get the picture.
For employee purchases, startup-centric credit cards like Brex, Divvy and Ramp allow business leaders to assign cards to employees, and set different spending limits and approval flows as part of the card management process. Implementing one of these systems can save a considerable about of time and paperwork when it comes to managing employee expenses with controls and approval flows. Learn more about the different types of startup business credit cards and how they can be helpful in adhering to accounting approval processes here.
Zeni specializes in working with technology startups and ensures they are audit ready around the clock. Tax documents are very confusing, and it’s often challenging and time-consuming to get everything ready on your own. This is especially true if you’re new to business and facing an audit for the first time. If you try to keep all your financial records, you may make a mistake in your paperwork.
If your startup is required to have an audit it’s essential that you follow the necessary procedures, and effectively communicate to get through the audit as quickly and efficiently as possible.
For an audit to be successful, effective communication is needed between everyone involved. Aim to develop a healthy working relationship with the audit team and make yourself available if they need to contact you.
Weekly meetings are typically recommended to review the status of the audit process, such as open items, roadblocks and next steps. This allows both parties to ask questions and discuss any potential issues to make the process less stressful and more streamlined.
It’s challenging to balance your day-to-day business activities with everything that needs to be addressed with the audit. However, it’s essential to make the audit your number one priority if you want a successful audit. Depending on the size and scale of your business, it may be beneficial to form an audit committee of key individuals across your organization who can help manage elements of the audit.
If issues arise during an audit, address them as soon as possible. Don’t put things off until a later date, as this will likely delay the audit. It’s also a good idea to ask the auditors when they need specific items completed. Asking for a deadline will help ensure that your audit runs smoothly.
Prior to the first day of audit fieldwork, you’ll likely receive a prepared-by-client list (PBC). If your books are maintained, closed monthly and all accounts are reconciled you will have 90% of the items requested on this list ready to go.
Establish an audit folder and include all these documents. Best practice is to use the PBC numbering schema in your file name to easily track the items. Many audit firms also have portals in which these files can be uploaded.
Whether you’re facing an audit or not, it’s crucial to have solid financial infrastructure supporting your business so you’re ready for whatever may come your way.
Zeni is a full-service finance firm that provides bookkeeping, accounting, and CFO services for startups and small businesses. Advanced bookkeeping practices are core to Zeni’s offering, and are included in all our service plans. This ensures Zeni customers finances are always audit-ready. Startups love Zeni for a variety of reasons:
We use artificial intelligence and machine learning to complete your bookkeeping daily to GAAP standards, and manage every bookkeeping and accounting task quickly and accurately. Should your startup be audited, you can get started immediately with up-to-date books and financial records at the ready -- and Zeni standing by to help out along the way.
Zeni automatically tracks, reconciles, and stores all invoices and receipts on behalf of our Full-Service Plan customers. We are proactive in requesting important financial documents and information to ensure Zeni customers’ records are always up-to-date and audit-ready.
Our team draws on decades of experience to give detailed answers to your questions. We’ll tell you the pros, cons, and best practices for your business to support your strategic decision-making process.
You get a single point of contact for all your queries, so there’s no back-and-forth around finding the right person to speak with. Requests are assigned to team members with the appropriate expertise, so you get an informed answer fast. Plus, you have 24/7 access to a finance dashboard and finance concierge.
No need to wait for your accountant to deliver your financial reporting documents or respond with the metrics you need: Access up-to-date financial data instantly on the Zeni Dashboard at anytime, from anywhere.
Most bookkeeping services charge an hourly rate for their services, which can be an unpredictable cost each month. Instead, Zeni charges a set monthly fee for all your bookkeeping, no matter how many transactions you have or how complex your finances are.
As your business grows, our team can continue to offer the additional finance support you need, including complex accounting, CFO-level guidance, and yearly tax returns (including R&D tax credit).