Do you own a business that is partially financed through a line-of-credit or loan from a bank? Or are you an entrepreneur whose new business venture is taking off and you need access to capital from creditors or outside investors to maintain your upward momentum? If so, chances are good that you have been asked to provide company financial statements to creditors or investors, or you will be required to do so very soon.
Third parties can require different levels of assurance from your financial statements. The required level of assurance will depend on the size of your company, the dollar amount of the loan/investment and the amount of risk perceived by the third party. The different types of financial statements are described below, including one new option that might be a good fit for some companies.
Internally Prepared – you generate financial statements from your internal accounting software program. This is the easiest and cheapest option because you do not need assistance from a CPA, but these financial statements are generally considered the least reliable by creditors/investors.
Compilation – a CPA assists management in presenting the financial statements and provides a written report but offers no opinion or assurance regarding the reliability of the information presented. The CPA need not be independent of the company, but a lack of independence must be disclosed in the report. A compilation is less involved and less expensive than a review or audit. The creditor/investor typically prefers this option to internally prepared statements because they know that a CPA helped to prepare the statements or at least looked at the numbers.
Preparation – this is a newly available option that is similar to a compilation in that a CPA assists management, but there is no requirement for the CPA to issue a report or to consider or disclose whether they are independent of the company. Because this option is still new, it is unknown how accepting third parties will be of this alternative, but reduced compliance requirements are expected to result in lower costs to the business owner.
Review – a CPA (must be independent) performs inquiries and analytical procedures and provides limited assurance that there are no material changes that must be made to the financial statements. Reviews are more involved and costly than a compilation but less so than an audit.
Audit – a CPA (must be independent) obtains an understanding of the company’s internal control, assesses risks and performs testing in order to issue an opinion regarding whether the financial statements are fairly presented. Banks will often require audited financial statements for larger loans to help mitigate the increased risk. Because of the extensive work necessary to be able to provide the required assurances, a financial statement audit is the most time-consuming and costly of these options.
For a more thorough breakdown of the differences between compilations, reviews and audits, check out this comparative overview from the American Institute of CPAs: Comparative Overview
It is important for business owners to be familiar with the different types of financial statements and to clearly understand the needs of third parties. If your company already has a financial statement requirement, you may be able to reduce your costs by reaching out to your creditors/investors to see if they would be willing to accept one of the lower levels of assurance.
Written by: Todd M. Kennedy, CPA