Financial Controls and Audit Readiness: Preparing for Due Diligence
Master financial controls. Implement systems, prepare audits, ensure compliance.
Key Takeaways
- Financial controls: Systems ensuring accurate financial reporting, preventing errors and fraud. Key controls: Revenue recognition (correct invoicing, timing), expense tracking (all expenses recorded), bank reconciliation (accounts match bank), approval workflows (spending authorized). Cost: Accounting staff time, tools. Benefit: Accurate financials (better decisions), audit-ready (faster fundraising), fraud prevention (reduce risk).
- Audit preparation: Be ready for investor audits (Series A+) or external audits (IPO). Requirements: Clean books (all transactions recorded), documented processes (how are we accounting?), strong internal controls. Cost: Accountant time (prep, coordination), auditor fees (£5-50K depending on size). Benefit: Credibility (audited = trustworthy), faster closing (less questions).
- Controls by function: Revenue (contracts, invoicing, revenue recognition), expenses (approval, coding, monthly close), payroll (withholding, records, compliance), cash (reconciliation, controls). Implementation: Start with small company basics (monthly close, reconciliation), mature to formal controls (segregation of duties, documented procedures, audits).
Building Financial Controls and Audit Readiness
Establishing systems for accuracy and compliance. **Financial controls framework** Definition: - Policies and procedures ensuring: - Accurate financial reporting - Compliance with laws/standards - Fraud prevention - Asset protection Core controls: Authorization: - Spending approved before payment (no unauthorized spend) - Approval limits (£500 approver, £5K manager, £50K CEO) - Documented (trail of approvals) Segregation of duties: - Requestor ≠ Approver ≠ Processor ≠ Reconciler - Prevents one person from committing fraud - Example: Sales requests order, finance approves, ops processes, accounting reconciles Reconciliation: - Bank account: Reconcile monthly (deposits/withdrawals match) - Balance sheet: Reconcile accounts quarterly (add up correctly) - Aging reports: AR, AP aged (who owes us, who we owe) Documentation: - Contracts: Signed (proof of transaction) - Invoices: Detailed (description, amounts, terms) - Receipts: Kept (backup for expenses) - Journals: Trail of entries (how recorded) **Revenue controls** Contracts: - Standard terms: Payment terms, conditions, deliverables - Approval: CFO signs (legal authority) - Storage: Filed and indexed - Risk: Missing contract = dispute (who agreed to what?) Invoicing: - Template: Consistent format - Details: Customer, amount, invoice number, date, payment terms - Timing: Invoice when service delivered (revenue recognition rule) - Tracking: Invoice number sequence (can't skip, no gaps = fewer errors) Revenue recognition: - Method: Recognize when earned (not when paid) - Example: 12-month contract (£12K), recognize £1K/month - Rule: ASC 606 (accounting standard) - Documentation: Journal entry showing calculation Billing system: - Automated: Reduces errors, faster invoicing - Reconciliation: Billing vs revenue recognized (should match) - Tools: Stripe, Zuora, bill.com **Expense controls** Approval workflow: - Request: Employee submits (amount, purpose) - Manager approval: Is this necessary? Is amount reasonable? - Finance approval: Is it coded correctly? Do we have budget? - Payment: Approved invoice paid Example amounts: - <£500: Manager approval only - £500-2K: Manager + Finance approval - £2K-10K: Manager + Finance + Department head - >£10K: Manager + Finance + Executive approval Documentation: - Expense approval form (what is being spent, why) - Receipt (proof of cost) - Coding (what account to charge to) - PO number (for tracking) Monthly expense review: - All expenses reconciled to invoices (amounts match) - All expenses coded correctly (tax, department, etc.) - No duplicate payments (same invoice paid twice) - Unusual items flagged (one-time items, large amounts) **Payroll controls** Setup: - Written policy (salary, benefits, PTO terms) - Employment agreements (job title, compensation, terms) - Tax setup (W-4s, tax withholding) Processing: - Time tracking: Hours worked (for hourly) - Approval: Manager approves timesheet - Payroll run: Payroll processed correctly - Taxes: Correct withholding applied - Compliance: Payroll taxes filed/paid correctly Monthly verification: - Headcount: Who's on payroll? (catch errors) - Amounts: Did people get paid correctly? - Deductions: Were benefits, taxes deducted? - Reconciliation: Payroll expense reconciled to GL Annual: - W-2 prep: Total compensation, withholding correct - Tax filing: All taxes paid, files submitted - Audit: Payroll records organized for auditor **Cash controls** Bank reconciliation: - Monthly: Compare bank statement to accounting books - Timing: Cash in bank should match cash in accounting - Investigation: Any differences explained (outstanding checks, deposits) - Frequency: Monthly minimum, some companies weekly/daily for large balances Example reconciliation: Bank statement: £50,000 - Outstanding checks: -£5,000 (checks written not cleared) - Deposits in transit: +£3,000 (deposits not yet shown) - Adjusted bank: £48,000 Accounting books: £48,000 ✓ (Match!) Internal controls: - Segregation: Approver ≠ Signer ≠ Reconciler - Dual signature: Large checks require two signatures - Monitoring: CFO reviews all bank transfers - Security: Limited access to bank portal **Audit readiness** Preparation timeline: 6 months before (planning): - Meet with auditor (understand scope, timeline) - Assess readiness (what needs fixing?) - Create checklist (documents needed) 3 months before (organizing): - Organize documents (contracts, invoices, payroll) - Reconcile accounts (make sure books clean) - Prepare schedules (list of accounts, amounts) - Draft footnotes (explain significant items) 1 month before (finalization): - Final reconciliations (everything agrees) - Walk-through meeting (auditor reviews scope) - Gather missing docs (resolve any gaps) During audit (2-4 weeks): - Auditor reviews sample of transactions - Tests controls (are they working?) - Interviews staff (understand processes) - Requests documentation (contracts, approvals, reconciliations) Post-audit: - Review findings (issues, recommendations) - Corrective action plan (how will we fix?) - Signed audit report (auditor certifies financials) Typical audit fees by company size: | Revenue | Employees | Cost | |---|---|---| | £1-5M | 5-20 | £5-15K | | £5-20M | 20-100 | £15-40K | | £20-50M | 100-300 | £40-80K | | £50M+ | 300+ | £80K+ | **Controls maturity by stage** Early stage (seed, <10 people): - Basic: Monthly close, bank reconciliation - Tools: Spreadsheet, basic accounting software - Process: Founder does accounting, accountant does taxes - Audits: None (bootstrap) Growth stage (Series A/B, 10-50 people): - Intermediate: Monthly close, revenue controls, expense approvals - Tools: Accounting software (Xero, Quickbooks, FreshBooks) - Process: Dedicated accountant, outsourced bookkeeper - Audits: Internal review (accountant), no external audit yet Scale stage (Series B/C, 50-200 people): - Advanced: Monthly/quarterly close, full controls, internal audit - Tools: Enterprise accounting system (NetSuite, Workday) - Process: Accounting team (general ledger, AR, AP, payroll) - Audits: Annual external audit (prepare for Series C investor requirements) Mature stage (IPO-ready, 200+ people): - Formal: Monthly close, quarterly review, annual external audit - Tools: Enterprise systems with strong controls - Process: Internal audit team, CFO, audit committee - Audits: External auditor, SEC compliance (if public) **Implementation roadmap** Month 1-2: Foundation - Document current processes (how are we doing things?) - Create approval policy (who approves what) - Set up chart of accounts (consistent coding) - Monthly close process (document steps) Month 3-4: Revenue controls - Contract template (standard terms) - Revenue recognition policy (when to invoice) - Reconciliation: Billing vs revenue - Testing: Walk through revenue cycle Month 5-6: Expense controls - Approval workflow (documented, implemented) - Chart of accounts (full coding structure) - Monthly reconciliation (expenses → GL) - Testing: Walk through expense cycle Month 7-8: Payroll controls - Policy document (compensation, PTO, benefits) - Payroll process (how salary determined, taxes calculated) - Monthly verification (headcount, amounts) - Annual reconciliation (W-2s, tax filings) Month 9+: Audit readiness - Organize documents (contracts, invoices, payroll records) - Reconcile all accounts (make sure everything agrees) - Controls testing (are they working?) - Prepare audit schedules (summary of amounts) **Common control failures** Failure 1: Lack of approval - Risk: Unauthorized spending, fraud - Example: Employee approves own expenses - Fix: Segregation of duties, approval workflow Failure 2: Poor documentation - Risk: Can't audit transactions, fraud undetected - Example: Large payment with no explanation - Fix: Require documentation (invoice, contract, memo) Failure 3: Revenue timing errors - Risk: Revenue recognized in wrong period (over/under statements) - Example: Invoice month 12, collect month 1 (which period?) - Fix: Revenue recognition policy (when earned, not when paid) Failure 4: Missing reconciliations - Risk: Bank account errors, GL discrepancies undetected - Example: Missing deposit, never found out - Fix: Monthly bank reconciliation, monthly GL review Failure 5: No segregation of duties - Risk: One person can commit fraud, not caught - Example: One person approves and processes payments - Fix: Different people for approve/process/reconcile