In 2018 the owner of a metal manufacturing company in Southern California asked me a question that was not easy to answer. "Should I spend the time and money to get an audit?"
His company had 8 employees and consistent revenues between $2 Million to $3 Million. He ran his accounting through Quickbooks Online and had no problem producing what looked to be reliable P&L's, balance sheets and cash flow statements.
Any business broker can share stories about horrible bookkeeping practices they’ve encountered, where owners wanted to sell a business with negligible or dubious records. This was not one of those. This company had a sharp in-house bookkeeper who paid attention to best practices.
My response was a rather lukewarm "you probably don't need to go through all that. Your reports seem to be in pretty good shape."
The owner made me eat my wishy-washy words. He went on to spend two months and $14,000 on a full financial audit conducted by a third-party CPA firm. He never confided in me, but I got the sense he had doubts about some of his company's accounting practices.
The audit did not turn up anything earth shattering apparently. What it did accomplish was put his business in an incredibly strong position for sale. The owner wound up listing his business with another broker (maybe that broker recommended the audit, I'm not sure).
The business received more than a dozen offers. The sale price came up a tad short of the asking price but they were seeking a huge multiple based on the reliability of the financials and the company's strong history. That $14,000 investment conceivably netted him half a million dollars.
Audits are a pain. Even the CPA’s who do them agree. Are they worth the hassle and expense? It's not a simple answer.
As a sales advisor, it’s almost a heavenly experience marketing a business with audited financials. I’ve been a broker of mostly Main Street businesses since 2005 and only represented one company with audited books.
There are three categories of audits - operational, financial and compliance. Most privately-held companies will perform a financial audit, conducted by an outside CPA firm. You can pretty much guarantee the work will cost a minimum of $10,000 and require more than a month.
PRO Audit Arguments:
The larger the company, the stronger the argument for a pre-sale audit. In my view, audits are most helpful for businesses doing $2 Million to $10 Million in revenues but do not operate with a controller or accounting VP. Management structure has a lot to do with the decision. Auditing helps in detecting fraud, assessing risk, studying cash flow patterns and examining controls in place.
Business buyers will grant an audited company instant credibility, reduced risk, and increased comfort, as they move forward in their pursuit of a purchase. This credibility gets reinforced by other buyers when multiple offers roll in.
In our specialty, the sale of property management and property-related service businesses, an audit is tremendously powerful. There are, unfortunately, numerous cases of mishandling of company funds, legal and compliance issues, and internal mismanagement, all of which are addressed and overcome through audits.
ANTI Audit Arguments:
There are a considerable number of small businesses where an audit doesn’t make sense. There needs to be a certain level of accounting proficiency already in place before an auditor can begin.
Companies operating on paper receipts, occasional invoices and poor cash handling are not a good fit. Neither are businesses doing $200K or $300K in revenues. If you would struggle to produce profit and loss statements or balance sheets, an audit is probably too tall a hurdle.
If you are super-sensitive to having your corporate returns examined, not a good fit. Businesses who don't perform monthly reconciliations may not be a good fit either.
Conversely, larger companies who have a controller or accounting team on staff may find audits unnecessary. The strength of their reporting will speak for itself when a buyer begins due diligence.
So fellow brokers and business owners, how do you feel if someone asks "is an audit really worth the hassle?"