What is Financial Auditing & Advantages of Financial Audit of a Company?

Tally Solutions | Updated on: January 17, 2023

What is a financial audit?
Types of audits
Advantages of auditing a company

A company maintains records of all its financial transactions. An accountant manages and maintains these records and generates statements based on these records. The financial statements of the company can be used internally and externally. The detailed daily, weekly and monthly statements are usually used by management to govern the performance and productivity of the company. The detailed statements help the company set goals and determine if they have successfully achieved . The monthly, quarterly, and annual statements are of interest to the internal management, shareholders, investors, financial institutions, and authorities. To ensure that the presented financial statements are fair and true, audits are conducted. Financial auditing is the process of analyzing a company's financial records and determining if they are accurate and that there has been no malpractice, misrepresentation, or financial mismanagement. Audited reports are also mandatory for submission to certain authorities and institutions.

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What is a financial audit?

An audit is an auditor's analysis and verification of a company’s financial statements and records. The auditor verifies the records and statements of the company to see if they are accurate and a fair representation of the company’s financial situation and transactions. The accounts are also checked to see if they follow the acceptable accounting norms and if there is any misstatement or malpractice in the calculation and generation of the financial statements.

In addition to the financial records and statements, an audit checks the company’s internal controls for effectiveness. An audit examines the accounting processes and helps identify ways to streamline and improve them. It provides an expert opinion on whether processes can be improved .

Auditors are usually selected by the board of directors or management. They are selected to be people who are not connected to the business or the business's accounting process in any way. This ensures objectivity and unbiased reviews of the company’s accounting system, controls and financial statements. The investors, shareholders and owners of the company can rest assured that the financial statements that they are presented with are true. An audit also ensures that the financial accounting practices that are being followed are as per the accepted accounting standards and company policies. This avoids manipulating the financial statements by using the wrong calculation methods and accounting practices.

Types of audits

A company can perform two main types of audits: external and internal audits.

External Audits

External audits are performed by auditors or an auditing firm. They are unbiased auditors who examine and review the company’s financials and financial statements. One of the main objectives of an external audit is to confirm if the company’s financial statements are true. An external audit will try to determine if there are any misrepresentations or misstatements in the financial statements. External auditing gives the stakeholders the confidence to make important decisions based on the financial statements that are released by the company.

A company’s accountants may become accustomed to using a set process or procedures. However, an external auditor examines the accounts to see if they are as per the acceptable accounting standards. The company may also have internal controls in place. An external auditor will be able to determine if these controls are effective. Since the external auditor is not invested in the process or operations, he/she is unbiased. The external auditor will be able to assess the processes and controls objectively. The auditor’s experience and expertise will help the company continually improve its processes and controls.

Internal Audits

Internal financial auditing is performed by the employees of the company. They report directly to the management, and their reports are used internally. An internal audit determines if the company’s controls are effective and if the processes are working as they should be. Since the internal auditor is a part of the process, they are less likely to criticize the process too much. Since the auditors assess their own operations and processes, they are less likely to be objective.

Internal audits give the management feedback based on which they make their decisions. Internal audits also verify the accuracy, compliance and completeness of the records. Internal audits are performed more frequently than external audits and can be used to identify personnel or departments who are not maintaining their records properly. Regular internal audits keep the company’s financial accounting procedures aligned and help the company prepare for external audits.

Advantages of auditing a company

Some of the main advantages of financial auditing are:

Consistency and compliance

Auditors are experts in financial accounting standards as well as the local laws and regulations. If the company is intentionally or unintentionally not compliant with accounting standards or the law, an audit will be able to identify the same

Effective systems and controls

An objective assessment of the company’s processes and internal controls provide valuable feedback. Regular audits help the company evolve its systems and controls to be effective.

Easier insurance claims

Insurance claims are usually disbursed only after a full audit to verify the value of the claimed damage. When audits are performed regularly, the insurance companies know that the amount that is being claimed is correct.

Examine profit or loss

Audited financial statements provide a clear picture of the financial status of the business. One of the advantages of financial auditing is that one can clearly determine if the company is making a profit or a loss or any problem areas. An audited financial statement is an essential management tool for informed decision making. Comparing subsequent reports also helps determine if any changes in policy have impacted the finances.

Obtaining finance and investments

Audited reports enhance the reputation and trustworthiness of a company. A company that has a history of maintaining audited financial reports is more attractive to investors and financial institutions. So attracting investments and obtaining loans is easier when the company has a set of audited reports.

Easier winding up

In the event of winding up or selling the business, a correct valuation of the company is essential. An audited financial statement shows the value of the assets and liabilities of a company. It makes it easier to find and negotiate with buyers when the paperwork has been audited.

Easier tax calculations

The tax that a company is liable to pay depends on the profit and other factors in the financial statements. Audited reports are essential to make accurate calculations of taxes to be paid. Submission of audited reports is mandatory for certain government filings.

Fraud detection

Unfortunately, fraud and embezzlement happen in some organizations. Regular audits help detect such cases of fraud. Auditors can also help the company take suitable action against the offenders. Financial auditing also acts as a preventive measure for potential offenders who will be less likely to attempt fraud when they know that the accounts will be checked thoroughly. Fraud prevention is also one of the advantages of financial auditing.

Better planning and budgeting

A reliable set of financial documents at regular intervals help identify business trends. Accurate reports equip management with the information that they need to make better decisions. Financial data helps the company plan for the future and allocate budgets. Better decision making makes a company more competitive and successful.

Gathers evidence

In the case of detection of malpractice by the auditor, the process of financial auditing gathers the evidence required to prove the malpractice. An auditor cannot make allegations of malpractices without having such evidence in hand. Once there is proof of wrongdoing, it is more difficult for the wrongdoer to cover their tracks.

Increases credibility and reputation

When an auditor gives a report of all the accounts being in order, it enhances the trust that the company’s board, owners and stakeholders have in the management. It also boosts the morale of the company’s personnel who know that their work has been examined and that they have done their jobs well. The image, respect and goodwill of the company get a boost after a favorable auditor’s report.