Financial statements can serve as incredible decision-making tools, especially to owners of small and growing businesses. But financial statements are only as helpful as they are accurate. By soliciting help from a CPA firm – specifically one that specializes in assurance services – businesses can improve the readability, accuracy, and reliability of their financials. Not only will this help management make better business decisions, it will introduce a level of credibility to the reports that financial institutions, surety bond companies, banks, investors, and other stakeholders are seeking.
An external CPA firm can perform a number of services to help improve the presentation of financial reports, but three of the most common are compilations, reviews, and audits. Each service produces a different deliverable and provides management with different levels of assurance, but each has its place in the business world.
Compilation – the Lowest Level of Assurance
Compilations are a great place for businesses to begin their foray into the world of assurance services. A CPA firm will perform compilations when management needs assistance preparing their financial statements. Using the trial balance management provides, the CPA will configure the data into a format that follows a standard accounting framework like Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). The CPA will not provide any assurance as to the accuracy of the numbers, but they will ask for documents to support key balances (like cash accounts, loan balances, and mortgages) and will speak up if they notice any material misstatements.
Compilations can help when businesses are looking to expand their operations. Management will have a better understanding for how their financial information should be organized and can make better business decisions based off those values. Compiled financials may also be requested from banks or lenders. While larger banks often require a report that provides some sort of assurance to its accuracy, many will accept compiled financials to expand credit lines to existing clients or open credit to new clients when there is significant collateral in place.
Compilations can also serve individuals. Individuals with extensive business holdings or other high-valued assets often seek a report that summarizes their assets, liabilities, and net worth. Compiled personal financial statements can help individuals when planning for retirement, and they are often requested from business partners or as part of investment negotiations.
Audit – the Highest Level of Assurance
Audits are on the opposite end of the spectrum from compilations. Audits attest that the financial statements and their associated disclosures are free from material misstatements. To provide this level of assurance, the auditor must perform a series of tests, including corroborating numbers with third parties, observing tasks being performed, reperforming tasks, physically inspecting assets, testing internal controls, asking questions of employees, and others. With the evidence they collect, they can form a professional opinion on the accuracy of the financial statements and ascertain if those reports comply with the pertinent accounting standards.
There are four types of opinions that auditors can issue. Unmodified opinions indicate the auditor has no concerns with the report as presented. Modified opinions reveal that the auditor encountered some issue when performing the audit and that there may be a material misstatement they were unable to identify. Auditors issue disclaimers of opinion and adverse opinions when they want to distance themselves from the reports and do not provide any assurance as to their accuracy. None of these opinions indicate how the auditor feels about the health of the company; rather, they indicate if the reports fairly represent the company’s financial position. Many banks and surety companies will only find unmodified opinions acceptable, but some shareholders, customers, and lenders will accept a modified opinion depending on the reason for the qualification.
For an auditor to attest to such a high level of accuracy, they must prove their independence from the company. If they have closely participated in the preparation of the financial statements – whether directly or through business or family ties – they cannot issue a clean opinion.
Management should consider a full audit if they are:
- Planning to sell the business
- Seeking new financing
- Preparing for an initial public offering
- Soliciting funding from the Federal government or from a state or local authority
- Going through a bond approval process
Review – Somewhere In Between
When businesses need some level of assurance but do not need a full-blown audit report, a review becomes a great option. Reviews are a great compromise for companies in the growth stage because they are less expensive and less involved than audits, but they still provide some level of assurance that the reports are accurate.
Because the scope of a review is condensed compared to an audit, the auditor can only provide limited assurance. But limited assurance may be all that a company needs. Reviews often suffice when management is seeking low to moderate levels of financing, and they can be used to satisfy the reporting requirements of their existing loan covenants and/or bonding capacity.
When performing reviews, CPAs make general inquiries and perform broad analytical reviews of the financial information management provides. They do not assess internal controls, assess fraud risk, or provide a professional opinion on the accuracy of the financials. Instead, they seek to answer the question, “do these numbers make sense?”
|Objective||Level of Assurance||Level of Work Performed||Independence Required||Price|
|Compilation||To help management present the company’s financial information||None||Low||No||$|
|Review||To obtain limited assurance that the financial statements are presented in accordance with a specified reporting framework (GAAP, IFRS) and that they are free from obvious material misstatements.||Moderate||Moderate||Yes||$$|
|Audit||To obtain reasonable assurance that the financial statements are free from material misstatements, and that the company’s information is fairly presented in accordance with a specified reporting framework (GAAP, IFRS).||High||High||Yes||$$$|
Making the Right Selection
Obtaining an external financial analysis can be just the thing your business needs to grow and thrive. If you know you would benefit from a financial assessment but you’re unsure which level of assurance you need, please reach out to us. We would love to help you determine your (and your business’s) best path forward.