In preparing for a financial audit or review, it is important to take a look at your year-end income statement balances as compared to the prior year balances. If there were large fluctuations, be prepared with explanations that are well thought-out.
Pay particular attention to accounts comprising your gross margin. How was this year’s sales as compared to last year’s? How do your sales represent trends in your industry? Are there general economic trends affecting your industry? What do you anticipate in the next year? What are trends with your suppliers? Are your materials or labor costs rising, and if so, are you able to adjust your pricing so that margins are not being squeezed? How do you plan to meet changes in technology? New competitors? Have you done a SWOT analysis (Strengths, Weaknesses, Opportunities, Threats)? Your CPA wants to know that management of your business is looking over the horizon and preparing appropriately.
Your CPA will look at key ratios such as your gross margin as a percentage of sales as compared to prior periods. If there are changes, make sure you understand why. Anticipating these questions will make you look well prepared and on top of your business issues, which should help ensure your audit or review goes smoothly.
Payroll costs are another significant component of a balance sheet. Look at your total payroll dollars as compared to your head counts in the current year as compared to prior years. If there were changes in key personnel, be prepared with explanations including why as well as what the dollar impact of those changes are. Look at all of your payroll dollars, including taxes and benefits, and be prepared to explain any changes. Did you pay more in bonuses as a result of higher sales this year vs. last? What was your average cost of living adjustment (COLA) this year? Have there been any changes in negotiations with labor unions, if your business deals with unions?
Legal costs are always a concern for CPAs. If you are involved in any litigation, be prepared to discuss it including the status and expected outcome. If you are being audited, be prepared for them to request independent correspondence from your attorney regarding significant litigation. Your attorney may bill you for providing this information.
Commitments, contingencies and subsequent events are always questions that come up in an audit or review. Does your organization have significant commitments extending beyond the financial statement date? This could include significant contracts with customers, suppliers, labor unions or others. Is there any indication of losses in the following year that you knew about at the balance sheet date? Do you have a tax audit in process or a significant lawsuit expected to be resolved unfavorably in the short term? Are there environmental issues that you know about? Do you have plans to close a facility or restructure in the near future? Was there a loss or significant new agreement (debt, etc.) subsequent to the financial statement date? In general, if it was probable and estimable at the financial statement date, it most likely needs to be reflected in your financial statements.
In addition, be prepared to speak about fraud and illegal acts. Whether you are having an audit or review, CPAs are required to talk with you about your knowledge of any fraud, actual or alleged, and any illegal acts of which you are aware. Be ready to represent to your CPAs that you are in compliance with all laws and regulations relevant to your business and industry. If you have received any notice of non-compliance from any regulatory agency, your auditors will ask to see it.
We hope that the guidelines presented in this series will help you better prepare for your audit or review, and help you look on top of your business. This will enable your CPAs to be efficient in their work and help you get back to running your own business in no time.
View previous articles in the series here: Part I – The Big Picture and Part II – Kicking the Tires on your Balance Sheet.