Financial audits are a fact of life for most businesses, no matter what their size or stage of development. From a startup seeking a new round of funding, to a growing company expanding its equity offering to employees, there are many reasons businesses need audits to ensure their finances are properly organized and compliant.
Many companies view an audit as something painful they have to endure. But it doesn’t have to be that way. If your company is preparing for an upcoming audit, here are four things you may want to consider as you navigate the process.
The audit process can be complex and challenging
The goal of a financial audit is to get a stamp of approval from an independent Certified Professional Accountant (CPA) that certifies that a company’s financial records are accurate and adhere to standard accounting principles. It’s a complex process and, as you can imagine, heading into it with your equity plan in disarray can lead to challenges.
“A painful audit would be any time there are inaccuracies and any type of discrepancy between the information that’s been accounted for from a financial reporting perspective,” says Holly Farlin, Vice-President, Products and Services Consultant at Shareworks by Morgan Stanley.
Farlin says if the data doesn’t add up, it can be a real challenge finding the specific details required to validate the information or reconcile the numbers.
It’s difficult to overstate the frustration you may encounter if you of have to track down missing equity data and hunt for documents. It can be time consuming, costly and a significant source of stress, especially if you’re searching for information for auditors at the last minute.
The audit process can be highly complex, especially when it comes to reporting on equity compensation. For example, if a company uses a traditional spreadsheet for cap table management and new versions are saved as new data gets added, it may end up with multiple versions of it’s cap table. This can lead to version control issues, confusion, data integrity issues and unnecessary backtracking. When audit time comes around, it may be difficult to locate the latest and correct version.
Good planning improves the audit experience
Having helped many private companies use the Shareworks equity plan management platform to prepare for audits, Farlin has seen what works and what doesn’t.
“I would say organization and centralization of data are key ,“ she said. “It’s equally important that when errors are found, they’re resolved as quickly as possible.”
When your equity plan is organized, data is centralized and document management is streamlined, you can complete the audit process more efficiently and confidently.
Without proper management of documents and data, companies may find themselves scrambling to locate information that’s stored in multiple places in various forms, like emails, paper documents and digital files. Hunting for that information can tie up finance teams for weeks and become a disruption to the business.
Some companies may find that storing everything in one place doesn’t just keep things organized, it also makes it easier for teams to collaborate, which is a great plus when it comes to managing equity compensation. It’s a complex activity that involves multiple departments, including human resources, finance and the tax team. Having equity data and documents in one place ensures everyone has access to the latest and most accurate information whenever they need it.
Beyond getting paperwork in order, companies can also improve the audit experience by understanding what’s coming. Typically, the fewer surprises, the better. It may be beneficial to try to anticipate what information and documents your company’s auditors might ask for. It’s also important for companies to consider specific auditing rules that might apply to their business.
During a first-time audit, there are some key factors that sometimes pose challenges for companies. One is revenue recognition, which essentially refers to the process of identifying what needs to be accounted for in your income statements. This is a complex topic that’s best determined ahead of time as part of establishing your company’s internal processes.
Stock option expensing is another complicated area. Using equity as compensation adds an extra level of complexity to an audit. For instance, stock has to be expensed according to specific requirements spelled out in ASC 718 – one of the accounting rules included in the GAAP (Generally Accepted Accounting Principles) or in IFRS 2, for companies operating outside the U.S. in places like the EU, Canada and Australia. (IFRS stands for International Financial Reporting Standards.
Transparency makes numbers audit ready
To do their work effectively, auditors need data that’s complete, accurate and easy to understand. In short, they need transparency.
As we mentioned, financial reporting is more complex when it comes to expensing stock options. One of the key components in accounting for stock options is determining their fair value, which is the price they could be purchased for in an open market as of a specific date.
Determining the fair value of a stock option requires precise calculations using a mathematical formula like the Black-Scholes pricing model, which gives auditors a clear view of how the value was determined. Transparency is also important when it comes to 409A valuations, which are required for any company offering equity as compensation to employees. To ensure they get audit-ready valuations and conclusions that are easy to validate, companies often work with 409A experts like Shareworks Valuation Services.
Once a company decides to transition to audited financials, there’s a new level of scrutiny that comes with it. For instance, ownership details must be clear and there’s a greater need for real-time information. As a result, companies often find it useful to centralize and automate option expensing so that it’s easier to track, report and share information.
Shareworks supports improved accuracy and access
Shareworks streamlines and automates the equity plan reporting process and gives auditors, investors and shareholders the transparency they need to make informed decisions.
Powerful equity plan reporting features provide flexibility and audit-ready accuracy. For example, the platform uses built-in calculators to determine the fair value of stock options, as well as other assumption calculations like forfeiture rates and dividend yield. These calculated figures are supported by detailed reports that enhance transparency and make equity portion of the audit process go more smoothly.
Shareworks also helps with data accuracy. Using its data imports functionality, equity administrators can enter large volumes of data automatically, reducing the risk or errors and minimizing the manual processing that’s required when using spreadsheets.
We’ve already talked about the benefits of keeping all your data in one place. With Shareworks, everything is stored on the secure, cloud-based platform, making it easy to record and track all equity plan information and activities.
There is also only one accurate and up-to-date cap table to manage, so there’s never a problem with multiple versions when it’s time to prepare for an audit.
Interested in learning more about how Shareworks by Morgan Stanley can help your company?
We’ve supported thousands of companies in the administration of their equity compensation plans and we’d be pleased to show you how Shareworks can help your company get organized and ready for your next audit.