Audit for Startups: How to Prepare for a Financial Audit?

India ranked 3rd in Global Startup Ecosystem following United States and China, according to the Global Innovation Index (GII) for the year 2021-2022 which was released by the World Intellectual Property Organization (WIPO).

India is currently witnessing a boost in the Startup sector with entrepreneurs coming up with different ideas and innovations. In the field of commercial trading, Startups are overtaking the concept of traditional businesses, which further has led to creation of a complete ecosystem for the same. As a Business entity, Startups at different stages seek requisite amount of funding in a timely manner. This is where an Audit plays the significant role. The Article below analyzes the Role of Audit for Startups, benefits of a financial Audit and stages at which startups may require an Audit.

Table of Content Abstract What are Start-Ups and why are they important? Meaning and Importance of Audit  Requirement of Audit for Startups Benefits of Audit of Startups  Documents required by Auditor for preparation of Financial Audit How to Prepare for a Financial Audit? Conclusion

Abstract

The fast growing expansion of the Startup platform has by time attracted the investors to engage with innovations and fund the ideas to meet its purpose. In such cases, the third parties such as Lenders and Investors having invested in a startup call for its Audit. This procedure helps in initiating the transparency in the allocation, use and flow of funds for the satisfaction that the investment is relocating in a desired manner.

Apart from third parties, the Board of Directors also call for such Audits to check accuracy of the financial statements of the Business and if the records are free from errors and contingencies. Such examination of records provides a brief overview of the management of finances by the organization.

What are Start-Ups and why are they important?

A Startup is a newly formed business with a purpose to grow rapidly by providing services at a larger scale based on demand of products and services in the market. However there is no straight jacket formula for a company to be called a Startup but the brief of it can be understood as an organization that adopts innovative ways to fill the gap in the market by making specific products and goods available at a larger scale. 

The working of a Startup is also different than a traditional business. But the suggestions show that for an organization to be called a Startup, it has to be of a certain size, receives a criteria based level of investment and funds. The test for identification for a startup can be considered by several factors such as;

• Area of acquisition of business in the market,
• Profitability of the business,
• Level of investment it receives, and etc.

Start- Ups are important as they have following benefits:

• Simple Procedure: The Indian government has created a website and a mobile app to facilitate startup registration. By completing a simple online form and attaching the essential papers, any corporation may begin a startup. The registration process is carried out entirely online.
• Self-Certification: Startups participating in the programme can certify that they are in compliance with three environmental regulations and six labour laws. Such certification is authorized for five years after the entity’s establishment.
• Simple money access: The government has set up a fund of 10,000 crore rupees to act as venture capital for new enterprises. The Government of India also gives a guarantee to lenders in order to encourage banks and other financial institutions to contribute venture capital.
• Cost savings: The government provides a list of trademark and patent facilitators. It provides low-cost, high-quality intellectual property rights services such as patent examination in a timely manner. Any facilitator fees will be covered by the government, and the startup will be liable for all statutory fees. As a consequence, the company benefits from an 80% decrease in the cost of submitting patents. In compared to other companies, we provide a 50% discount on trademark application.

Meaning and Importance of Audit 

Audit is an examination of some statements of figures of the funds in the books of accounts that hold the information relating to the profits earned and losses incurred by the entity during its operation. This procedure helps in creating transparency in the distribution and utilization of funds.

The procedure of Audit can also be defined as an ‘Investigation of evidences of financial records of the Business’ during which statement and figures of finances are examined and recorded by the Auditor and a report of it is prepared. Moreover, the examination of the Profit and Loss account and Balance sheet with Books of accounts is performed with a purpose to assure the truth of state of affairs of the information, justification and explanation that are recorded by the organization.

Requirement of Audit for Startups

Every business does not necessarily require an Audit. There are some parameters which necessitate a financial audit for an organization, which are different depending on the nature of the business and type of company. For a Startup, an Audit may be required in several situations, some of which are listed below; 

Lenders/Investors– In respect to Lenders and Investors, there can be two main circumstances when a financial audit may be required, which are explained as follows:

• For Existing Lenders and Investors– A financial audit provides a comprehensive view of company’s business and current state of affairs. Entities investing in a business may call for its Audit to receive an overview of company’s financial records.  An audit provides additional assurance to management’s assertions regarding the financial situation of the business.
• For interested Lenders and Investors– When an organization is properly audited, Lenders and Investors who are interested in investing in the business get an overview. Additionally, they may call for an Audit to know the company’s pre-revenue circumstances and to accumulate possibilities of Gains and Losses. 

Pre IPO (Initial Public Offering) – When an organization desires to list its small business as a public company to sell company’s shares to the public in general, in such situation an Audit may be required. As before public offering it is important to list company’s financial state with verified records.

Selling-off– There may be circumstances in which an organization may want to sell of their business. In such situation, having properly audited records will help the buyers in analyzing the risk factors, is any, in acquiring the business. 

Compulsory Audit-  In case of a Limited liability Partnership, if the turnover exceeds Rs 40,00,000/- or the contribution exceeds Rs 25,00,000/- in any year , an Audit is compulsory.

While on the other hand, for a Private Company, the accounts have to be compulsorily audited every financial year. A Private Limited Company has to appoint an Auditor within 30 days of its incorporation. The shareholders need to be informed if an Auditor is not appointed within 30 days of its incorporation. They require to appoint an Auditor within 90 days of its incorporation.

Benefits of Audit of Startups 

Apart from several clarifications with the financial records and its compliance with statutory requirements, there are several benefits of getting the books of accounts of a business Audited. Some of which are as follows;

• Early identification of errors,
• Prevention in the occurrence of fraud,
• Independent evaluation provides credibility to business,
• Confirms accuracy of the financial statements of the business,
• Helpful for the business owners in planning budgeting, capital expenditure etc,
• Ensures business’s regulatory requirement compliances,
• Provides recommendations, expert and unbiased notes for improvements by tracking down loopholes in management etc.

Thus, in a nutshell an Audit provides the organization with sufficient opportunities to fix any errors, maintain a transparency, assure the concerned authorities with the state of affairs and regulate the books of accounts.

Documents required by Auditor for preparation of Financial Audit

For the evaluation of the financial records of the organization, an Auditor will require several documentations. The recorded statements and documents that will be required are listed below, however the list is not exhaustive in nature and an Auditor may require some additional documentations relating to the finances of the Organization.

Trial Balances: Trial balance is the summary of the activities of business which reflect its financial position. It comprises of a list of all ledgers with balances. The ledgers consist of a compilation of multiple entries that are listed in various accounts. These records help the Auditors in taking a bird eye view of all the financial transactions made by the organization.

List of all Transactions: The organization that is being audited must mention all the transactions conducted within the specific duration with all the invoices and bills of the purchases that were made. The record of invoices help the Auditor in finding the total spending of the organization in the specified duration. With the help of which analyzing if the amount matches with the amount mentioned in the books of accounts gets easier.

Schedules: Organization with a financial structure dealing in commercial transactions as a part of accounting prepares various schedules like Depreciation, Prepayments, Accrual, and Asset Registers etc.

Equity and Debt financing documents: Documents relating to Equity securities consisting information that indicate the ownership in the organization is also required with documents of Debt securities indicating the loan taken by the organization. These documents help in identifying the source by which capital is raised by the Startup for the operation of its Business.

Significant Documents: Apart from above mentioned documents, one of the most important record is the list of all Material Documents which may include Invoices, Votes, Contracts and Material Agreements, Purchase orders, Progress Reports, Information of Financing, Bonding schedules etc.

Substantial supporting Records: During an Audit, supporting financial records are also needed which may include documents such as;

• Payroll Records
• Shipping numbers
• Tracking numbers
• Tax returns etc.

Loan Documents: While running a Startup, if loan is obtained to generate the funds, the documents concerning the loan and the transactions of the amount will be required to scrutinize the debt securities of the organization.

Legal Documents: In the process of Audit, legal documents of the organization are also collected for its verification. Memorandum, Articles of Association, License, Tax Registration Certificate (TRN), Share Certificates, Certificate of Incorporation etc. are such documents of legal nature.

Apart from the documents and records mentioned above, various other documents may also be required such as Bank statements, Previous Audit Report, Board meeting minutes, Employment Agreements etc. In a nutshell, Audit is a cross verification of the statements of records managed by the organization so as to provide a brief overview of loopholes or errors in its management, if any found.

How to Prepare for a Financial Audit?

While preparing for an Audit, it must be reviewed that the documents are professionally prepared and organized in a proper manner, as it will quicken the audit procedure. The documents should be stored in a secure virtual data room where the required information is readily accessible. It helps in smooth navigation of the process of Audit.

For the success of a Startup having strong financial records for all the transactions is also important, even if it doesn’t majorly affect your cash flow and the balance sheet. A financial audit is a great way for the validation of records, it provides a clear and comprehensive oversight of financial management by the organization. 

For a successful Audit, the first stage is its initial preparation. The Startups must make sure that the records are updated timely with the information of all financial transactions so as to avoid any shortfall at the end of the year. The points to consider while preparing for an Audit are as follows;

• Planning an Audit– Planning an Audit can be a tedious task. Adequate amount of time is required before preparing for an Audit as the procedure depends on the complexity of the financial records of the organization.  Each organization preparing for an Audit must keep one factor in mind that to meet the expectations from the Audit, allocate additional sources and keep all the records up to date. This will reduce the pressure at the time of an Audit.

• Follow Accounting Standards– Complying with the regulations is necessary for an organization to handle all the financial state of affairs in an uncomplicated manner. Almost every year there is an update in the Accounting Standards, Regulatory requirements and Legal requirements. Therefore, it will reduce the time to track important data and adopt changes to comply with all the newly introduced regulations if the finance team stays updated and familiar with all the developments instituted by regulatory bodies in accounting sector.
• Previous Audit Reports– When the Startup has been audited before, previous Audit reports may also be considered to analyze the changes that the organization witnessed in its financial situations from last audit. All the material changes are taken into consideration whenever an organization is audited. This helps in keeping a track of the changes that can potentially affect the auditing process. These changes may include any government grants or support given within the period, or investment in any new project. However, this does not limit to only financial changes but also non-financial changes should be considered such as alteration in internal control systems and management of accounting standards.
• Improvisation- Startups with experience in audit should consider previous year’s audit notes and recommendations to ensure that past mistakes are not repeated. For this an adequate review of the previous suggestions should be taken into account.
• Assigning Responsibilities– While preparing for an Audit, review the list of requirements of the Auditor and delegate the task to the financial team. Before an Audit it is important that the schedules are completed and necessary information/data are collected and organized to have Audit executed smoothly.
• Organizing Data– Documents that should be duly organized may include Fiscal year budgets, Transaction records, financial statements, General ledger, Invoices and bills and other working papers.

Conclusion

Hence, a financial audit helps a Startup in reviewing its state of affairs and it ensures that the financial information is accurately represented. It also verifies that the organization is preparing its financial statements in accordance with the updated accounting standards. 

For everyone including Investors, Lenders and authorities within the organization itself Audit works as an examination into the records and helps in eradicating any errors and contingencies, if found. This conclusively establishes transparency in the tracking the source of finances, its use, and accuracy in management of financial records of the business.