Running a small business can feel like you’re on a never-ending road trip — you constantly have to shift gears and map the day-to-day slog to ensure you’re on course. But if you don’t peer under the hood of your car on occasion, you might find yourself on the side of a highway, dealing with a roadside emergency.
That was my life when I helped run two businesses: my own content creation freelance business and an immersive art gallery (which opened during the pandemic, no less). It was hard to pause and double-check that the books were up-to-date and all the financials were in order.
To help you gauge your small business’s financial health, consider a small business audit. In a nutshell, this is a thorough review of your financial records and accounting processes, systems, and flow to ensure everything is accurate and current. An audit can also help pinpoint areas for improvement so your business finances stay in tip-top shape.
Fact: An IRS audit is rare. According to IRS data1, between 2013 and 2021, only 0.44% of individual and 0.74% of corporate returns were examined. As you can see, the odds of getting audited are pretty slim.
That said, conducting regular audits for your small business is still worthwhile. Let’s take a closer look at why.
Understanding the Purpose of a Small Business Audit
The term “audit” might cause you to stick your head in the sand out of fear. While there are IRS audits, there are also external audits, where you hire a third party to audit your small business. There are also internal audits, which you conduct within your own company.
As mentioned, the purpose of a small business audit is to ensure that your accounting processes and systems are effective and to check the accuracy and completeness of your financial records.
There are several types of audits, including:
- Financial audit: This is a thorough review of your financial records to ensure they’re accurate and in compliance with legal and financial standards.
- Operational audit: It can help you identify any blind spots in your accounting processes and systems or issues with your financial records that could use improvement.
- Compliance audit: This examines your small business’s adherence to regulations, laws, and internal policies. The primary purpose is to see if there are any gaps or risks in your practices that could harm your company.
When I was involved in running the immersive art gallery, I often wished we had conducted a more thorough internal audit or brought in a third party to do it. It could have helped us avoid costly mistakes and inaccuracies, while also identifying areas to improve our accounting processes — ultimately saving us time and money in the long run.
That said, we did hire a bookkeeper to clean up our books and counsel us on how to improve our processes. We also worked with a CPA to help streamline processes for preparing for the different filings (e.g., quarterly sales and tax returns for the state of California, 1099s for independent contractors, and annual city business taxes).
Preparing for a Small Business Audit
A small business audit doesn’t begin with the audit itself — there’s some preparation required. Before diving in, you’ll need to get organized and gather all the necessary documentation and information.
What you’ll need to collect largely depends on the type of audit, but can include:
- Invoices
- Tax returns
- Payroll records
- Receipts
- Confirmation of transactions
- Subcontractor and independent contractor documents
- Certificates of insurance (i.e., workers compensation, business insurance policy (BOP))
Ideally, you should reconcile your financial transactions with accounting software. While you might not need to have physical receipts on hand, digital records (think photos of your receipts) or transactions recorded through your accounting software may suffice.
Gathering the proper info and documents often takes longer than expected, so budget plenty of time to collect everything you need. Remember: missing necessary information can delay or complicate the auditing process.
Define audit objectives and scope.
You’ll also want to set the audit objectives and scope. What do you primarily want to achieve with an audit? For instance, your goal may be to improve your accounting processes or to ensure you’re up to speed with compliance matters.
If your processes and financial records are simple and in relatively good shape, you will only need to do an audit annually. If your processes are more complex or you anticipate they require a bit more cleanup, you might need to do an audit every six months, quarterly, or even monthly.
Budget and timeline.
Lastly, it’s helpful to establish a timeline and budget. The length of an audit hinges on its complexity, the type of audit, how much information is available, and how responsible and available both parties are to answering queries. If it’s an extensive review that covers more ground, expect your audit to be more time-consuming — and come with a higher price tag. You’ll want to factor this expense into your operating costs.
Conducting the Small Business Audit
After you complete the preparation step, the audit itself is an in-depth evaluation and review of your accounting processes and financial records. This involves reviewing your financial statements, records, and processes.
The evaluation stage of an audit also involves testing a sample of your transactions to make sure they’re accurate, complete, and consistent.
Another step of the auditing process is meeting with key staffers of your small business. The end goal? Clarifying anything that seems muddy and answering questions. If you fly solo with your business, make sure you factor in meeting time with the auditors. If you have a team, you’ll want to loop them in and schedule time to speak with the auditors as requested.
Once you’ve received the audit results, you’ll want to make the most of analyzing and addressing your findings, which we’ll discuss in greater detail next.
Best Practices for Small Business Audit Reporting
After you obtain your audit findings, you can use the results to make changes to improve your business.
Plan ahead.
For instance, maybe there were a few months where your financial records were inaccurate or inconsistent. This could be because it was a hectic time of year. When the art gallery sold out for several months, I was too busy running other aspects of the business to tend to bookkeeping and financial matters. To prepare, you may want to hire a professional to maintain financial records during peak seasons. You can also look into implementing new or more efficient processes to help you avoid making the same mistakes.
Communicate with your team.
If you work with a team for your small business, you should communicate audit results effectively and clearly with a proper sit-down. Give your team members plenty of time to ask questions and cultivate a safe space to field suggestions. Instead of framing it as a game of pointing fingers, use it as an opportunity to solve problems and ease the stress and hassle of inefficiencies in your operations.
Create an action plan.
Next, create a step-by-step action plan to make improvements. It might be helpful to focus on one area to improve upon. This can be the area that’s easiest to change or the one that can give your business the greatest impact. For the art gallery business, the easiest area to implement was staying up to speed with bookkeeping by hiring outside help.
You’ll also want to ensure your small business complies with audit regulations and standards. Look for what you’re missing and identify any potential blind spots. If necessary, consult outside help, such as a payroll provider or a tax or financial professional.
Implementing Audit Recommendations
Remember: It’s not an overnight process. Implementing all the changes you’d like to make could take some time. As mentioned before, focus on the areas that are either easiest to implement or have the greatest impact and go from there. You’ll want to create an action plan with a proper timeframe and budget for any changes you’d like to make to your accounting processes or financial record-keeping.
It’s important to regularly monitor your progress and the impact of any audit recommendations. Check in after a month or a quarter to assess your changes. Are your processes running more smoothly? Have you reduced compliance risks? Are your financial records more accurate?
At one point, after meeting with a financial professional, we realized we had too much workers’ compensation coverage. We changed our policy and saved some money, which went straight back into the business.
Auditing also isn’t a one-time deal. You’ll want to continue to implement changes and plan for future audits. As your small business evolves and grows, you might find new issues cropping up that you need to address.
Audits Are an Ongoing Affair
Sure, running a small business comes with so many moving parts that the idea of an audit might make you cringe. But taking the time and effort to conduct a thorough audit now can save you from bigger headaches down the road.
Additionally, an audit allows your team to identify any issues and collaborate on solutions. In the end, audits strengthen your business financially, and that kind of value is priceless.
- https://www.irs.gov/newsroom/irs-releases-2023-data-book-describing-agencys-transformation-through-statistics# ↩︎