More than just a commodity Featured

8:00pm EDT August 19, 2004
Owners of privately held corporations generally hesitate to have their financial statements audited.

One reason is that no statute requires audits for private companies -- current securities law requires public companies to be audited, but no such law governs private ventures. Another reason is that the cost of an audit outweighs the perceived benefits.

However inconsistent it may appear in light of the current landscape of failed financial statement audits, there is value to the owners of privately held corporations in a financial statement audit. Here are some benefits that can be expected from audits performed in accordance with Generally Accepted Auditing Standards (GAAS).

Maximize shareholder value in a sale or merger
Audited financial statements provide a sound basis for carrying out a business valuation when negotiating the sale of a business. Management representations are not sufficient generally in determining the financial position and performance of the target.

Independent auditors provide assurance on the reasonableness of the financial statements presented. This not only impacts valuation negotiations but may also enhance the marketability of the entity.

Another important factor related to the valuation and marketability of a business is the comparability of the financial information to the industry standard. One of the tenets of Generally Accepted Accounting Principles is that financial statements are comparable. This is one of the deliverables of audited financial statements.

Discovering fraud
White-collar fraud costs the American economy an estimated $100 billion each year. Financial statement audits conducted in accordance with GAAS are designed to obtain reasonable assurance that the financial statements are free of material misstatements caused by fraud.

Tests of transactions during an audit can significantly increase the probability of detecting fraud. This, in turn, results in the tightening of internal controls in order to mitigate future recurrences. It is also important to consider the legal costs of recovering stolen assets, which could end up costing more than the audit.

Having an auditor's fresh-eye perspective means that employees are less inclined to commit fraud knowing that there is a watchdog mechanism in place.

Relationships with customers and vendors
Government agencies often require audited financial statements either prior to awarding grants or contracts, or during the grant or contract term. Large creditors, including key vendors, often extend credit terms based on the financial stability of a company.

With the greater level of assurance on the financial reporting that is provided by an audit, it is possible to obtain more favorable credit terms from the vendor. Such benefits often outweigh the costs of the audit.

The reverse is also true. Think about a significant customer to whom a company extends substantial financing. There is greater peace of mind knowing that the customer's financial statements are audited by an independent auditor attesting to the financial condition of the business, instead of merely relying on the customer's representations that it has the resources to pay you.

Financing growth
Banks are more frequently requiring annual financial statement audits in order to extend financing to companies. Generally, the cost of capital to a company whose financial statements were previously audited is considerably cheaper compared to having financial statements that were not audited. Even a half a percentage point reduction in the interest rate on a $5 million loan results in pre-tax savings of $25,000.

Ultimately, positive cash flow and safeguarding of assets is what really matters to an investor. Recommendations that are byproducts of audits can enhance systems and procedures that are in place to safeguard assets.

A crucial benefit is that audits provide assurance as to whether the financial statements are presented free of any material misstatement, which increases the possibility of detecting any existing fraud and may prevent future fraud from occurring.

KAMAL PARAG (kparag@tbcpa.com) is a senior manager with Tauber & Balser P.C. in the forensic services department. Parag has 10 years of experience providing litigation support to clients in various litigation matters involving accounting and auditing issues, and providing assurance services to small and medium-sized entities, both closely held and publicly traded operating in several industries, including services, manufacturing and distribution. Reach him at (404) 814-4989.