Financial audit preparation

Author: Jaron Wright, CFA
Read time: 6 minutes
Published date: 12 December 2023

Learn what the process looks like for private companies, what auditors look for, and how to best prepare.

This comprehensive guide covers everything you need to know to tackle your financial audit with confidence. Audits can feel especially stressful if you haven't gone through one before, so we made a simple checklist to help you collect all the necessary documents for your first audit.

What is a financial audit?

A financial audit is a third-party evaluation of your company’s financial statements to assure investors, regulators, and other outside parties that your reported values are complete and accurate.

Depending on your company’s financial goals and growth, you may want an independent audit to:

• Appeal to outside investors and gain their trust
• Satisfy a requirement from an insurance company
• Get a loan from a bank

Financial audits are typically conducted annually.  A third-party accountant (an auditor) reviews the accounting practices and financial statements of your company and determines one of three  outcomes:

• Unqualified opinion (clean opinion): Your company has represented its financial operations correctly
• Qualified opinion: Your company’s accounting practices contain significant errors
• Adverse opinion: Your financial records are not aligned with GAAP (generally accepted accounting principles) and are egregiously misstated
• Disclaimer of opinion: The auditor was unable to complete the report because of insufficient financial statements or a lack of cooperation from the company

What triggers financial audits?

When a company is first incorporated, it can operate for some time with less complex bookkeeping. At this stage, startup accounting is mostly about tracking company progress and estimating cash burn rate.

After a Series A funding, accounting requirements get much more complicated. Investors might start pressuring companies to report out their financials—including their stock-based compensation expenses—in accordance with GAAP. For companies that have raised at least a Series A, the need to start financial audits may be triggered by a few events:

• Investor requirements in an equity financing
• In preparation for an initial public offering (IPO)
• Lender requirements in a debt financing, such as a bank loan or line of credit

Financial audit checklist: How to prepare

When time comes for your company to undergo a financial audit, there are a few things you can do in advance to make the process as smooth as possible.

Calculate your stock-based compensation expenses

Standard accounting guidance ASC 718 requires U.S. companies to disclose their stock-based compensation (SBC) expenses, as well as the method used to calculate that figure, in their annual income statement.

The ASC 718 guidelines include three basic steps for expensing employee-stock-based compensation:

• Calculate the fair value of the equity compensation
• Allocate the expense over the option’s useful economic life
• Reflect compensation expenses on your income statement

Hire an auditor

The next step is to hire a third-party auditor, preferably a well-regarded certified public accountant from a firm that has experience auditing private companies. If it’s your first financial audit, you may want to work with an auditor that’s recommended by your investors.

Organize your documentation

Once you’ve hired an auditor, compile your documentation. You will be emailed a document called a PBC (Prepared By Client list). This is a list of documents your auditor will need to review. For many companies, this includes making sure your cap table is up to date.

Update your Financial Reporting Value

Before you can add your stock-based compensation expenses to your income statement, verify you are using the most recent Financial Reporting Value (FRV) to calculate the expense.

Prepare financial reports for your auditor

Now that your equity data is up to date, it’s time to prepare financial reports for your auditor to review. Review your PBC list to learn what information the auditor needs to draft their opinion. You may need to share statements from both your current fiscal year and the previous fiscal year.

Financial audit best practices

Keep a good relationship with your auditor

Interacting with auditors professionally is crucial. Ask them what they need early in the process. Treat them as partners, and maintain a cooperative relationship throughout the audit.

Keep good records

Update your cap table monthly. This includes adding any newly issued options, updating your list of stakeholders, and entering any employee terminations or security cancellations promptly.

How Carta can help

Carta regularly  builds new features to help you stay compliant. Here is an overview of the recent additions:

Equity awards with performance conditions

If an award has a performance condition, it means that the award has a vesting condition that is subject to performance-based criteria.

Deferred Tax Asset

Deferred Tax Asset (DTA) is a line item on a company’s balance sheet that may reduce its taxable income in the future.

Modification accounting support

Did you make modifications to any securities this year? A modification includes, but is not limited to, a repricing or a vesting schedule change. The Carta team can help with your accounting and reporting approach.