A financial audit is a valuable tool for early stage companies to enhance transparency, build credibility, comply with regulations and support decision-making processes. It instills confidence in stakeholders and lays the groundwork for sustainable growth. It can be time consuming, especially during a first-time audit, but the sooner you put the right building blocks in place, the better the process will be as your company grows.
Much of the work will fall on the finance team, but there are steps along the way where it’s important for the CEO to be part of the process. An audit is a great opportunity for a CEO to get a holistic view of the financials of the business. You’ll get insight into your company’s financial health and its risk areas. Oftentimes the process leads to thoughtful conversations about how financial systems are set up. Don’t think about it as just an administrative process. There is a lot of value to the process.
The sooner the better in terms of establishing a set of internalized controls. It’s much harder to get these in place further down the road, and things will slip through the cracks and create problems if these controls aren’t in place as the company grows. Our advice is to look forward and think about yourself as a $100M business. There are things you’ll wish you had done earlier because it’s so much more simple when the company is small. A solid audit process is one of them.
At a recent masterclass for the Rally portfolio, we talked about how to think about and prepare for a financial audit. The session was led by James Lichau, Partner at BPM; John Hayashi, Managing Director at BPM; and Kendall Kuhn, Senior Manager at BPM. Rally Managing Director Charles Beeler moderated the session.
One key topic we discussed was the overall goal of an audit. Audits are directed towards delivering assurance at three levels:
- Shareholders and Other Stakeholders: Audits provide an independent opinion and report that adds credibility to financial information released by the business.
- The Board of Directors: Audits provide assistance to the board in discharging their corporate governance and compliance responsibilities. It helps the board understand the internal control environment and overall performance of the business.
- Management: Audits provide observations and advice on financial reporting, tax, business issues,operational efficiencies, accounting policies and procedures and related controls from senior professionals who have an understanding of your business and industry, including sharing experience on best practices.
We also talked through common pitfalls of an audit process:
- Resource Constraints. Especially at an early stage company, there is often a small finance team and many competing priorities against the audit. It takes time to gather all the information, find documentation and get a feel for the audit process.
- Inadequate Record Keeping. Auditors will look at all cash raised since inception. If there aren’t adequate records, they have to go back to the bank or attorneys, but this takes time to sort through. It’s a very common issue we see with first time audits.
- Understanding of the Audit Process. First year audits do take longer, generally anywhere from 3-4 months. After that first year, when you start to understand the process and have everything in line, it can be done in about 6 weeks.
- Fulfilling “Prepared by Client” Items. Auditors generally ask for at least 90% of the entire PBC list to be provided before they’ll begin work. The companies that do this correctly are significantly more efficient.
We also discussed SALT (State and Local Tax), which is a critical topic that ties into the audit process. SALT is an issue that needs to be addressed by all companies. It’s different today because of e-commerce. In the old days of brick and mortar, you didn’t have as much trouble keeping track of tax liabilities. Now, we’re a multi-state economy. What used to be simple is now very complex. The sooner you tackle, understand and keep track of SALT, the better off you will be. Don’t put it off. We should be thinking about SALT from the first customer.
Below are some key SALT topics we discussed:
- Multi-state Business Operations
- Today’s e-commerce and technology mean business operations are conducted from multiple locations in different state and local tax jurisdictions.
- Business activity must be tracked and sourced to multiple locations to compute the proper amount of state and local tax due.
- Lack of Uniformity in SALT Laws
- Each state and local tax jurisdiction will have its own system for generating tax revenue.
- Each system will have its own set of laws to determine taxable income and a set of tax rates to apply when computing the amount of tax to report and pay.
- Overpayments and Underpayments
- The inevitable result of multi-state business operations and the lack of uniformity in laws is the underpayment and overpayment of taxes.
- Proper internal and external resources are needed to make sure material underpayments and overpayments don’t result.
- Additional resources are needed to accurately report and pay underpayments and to file claims for refund of overpayments.
The content for this article was created from a recent masterclass on audit and SALT. Rally Ventures occasionally hosts masterclasses for our portfolio companies, led by experts and industry veterans.
