In the first of a series of columns designed to help small businesses run more efficiently, accountant Smith & Williamson examines the role of the external audit in cutting costs and improving management processes.
The Department of Trade and Industry is considering raising the audit exemption threshold to the average for European Union countries, which is turnover of £4.2m. The current threshold in the UK is £350 000.

“Great!” I hear you say. “If the exemption limit goes up to £4.2m, we won’t need to waste all that time and money on the annual audit. All we need the accountants for is to prepare our accounts and deal with the tax.”

But hold on a minute. Before you make any hasty decisions, have a look at the audit and what it is designed to achieve.

An audit typically analyses information from the previous year to give a snapshot of the current financial position of a business. But its real value is that it can provide information that can be used to improve the management and efficiency of an organisation.

Why bother with an external audit? Although the Registrar of Companies will accept internally produced abbreviated accounts, there are other interested parties that prefer financial reports to be checked by an external source.

Above all, an external audit ensures the reliability of the company’s financial statements. This is important, as stakeholders seek assurance that their investments are safe.

As well as shareholders, the list of concerned parties includes creditors, lenders, suppliers, potential investors, employees and regulators. Your banker may require audited accounts to assist its review of overdraft facilities, and may offer a better rate to customers that can provide externally audited accounts.

Similarly, suppliers may also want to see audited accounts before agreeing lines of credit or increasing credit limits.

Some of the benefits of an external audit are that it:

  • ensures reliability of a company’s accounts and internal systems

  • helps to reduce the cost of capital

  • deters fraud

  • indicates management ability

  • provides a useful basis for economic decisions

  • guarantees that financial reports are prepared regularly and to a deadline.

There are, of course, disadvantages to an external audit – not least the cost. The DTI recently suggested that a company with an annual turnover of £1m might save £1000-2000 a year if it did not have an annual external audit. However, this figure looks overstated, as many businesses would probably continue to use their accountants to prepare accounts and sort out tax. The savings are unlikely to be significant in terms of a company’s overheads budget.

Maximising the benefits of an audit

Good preparation for an external audit is time well spent – provided that the auditor has the necessary information at the outset to enable it to do the job efficiently. Once the audit is complete, management should expect advice from the auditor that can be applied to making the business operate more effectively.

But if the auditor has to spend time hunting for details, it will be less able to provide this feedback.

Key questions to ask your auditor

Since an audit involves a thorough review of a business, it is a good time to ask the auditor to consider your business from another angle. A business should receive valuable input that can result in savings that far outweigh costs. Outlined below are some key areas that professional firms may usefully address:

Time recording systems The existing system may be good, but is it good enough? When a firm’s profitability depends on time-keeping, it is essential that fee earners’ time is accurately noted, billed promptly and charged appropriately.

Credit control Simple but effective systems may be sufficient to ensure that invoices are routinely chased to improve cash flow. This may result in bank-borrowing being reduced or eliminated.

Disbursements If purchases are made on behalf of clients, these must naturally be charged promptly and accurately. This can be particularly difficult to manage if there are a lot of small purchases.

Staff remuneration Where the salary bill is large, relative to the total budget, an efficient means of payment is a priority. Bonus schemes and fringe benefits paid by the firm should be considered, along with tax implications.

Good rates from suppliers 

It is worth periodically reviewing the rates offered. Can better deals be obtained elsewhere? Are all available discounts being applied for? The key to a valuable audit is to work with your auditor and ascertain in advance what you want. Looking ahead, the impact of e-commerce on business may well result in a demand for more detailed and up-to-date information. Indeed, it could affect audits far more than any change in the exemption level, and as the pace of business accelerates, you may want to see more of your auditor in the future, not less.

Tips for an efficient audit

  • Request a pre-audit meeting to work out a precise remit and respective responsibilities – it is surprising how cost-effective this can be
  • Arrange with the auditor exactly what information will be required. It is much cheaper for you to provide it than for your auditor to search for it
  • Make sure that bank accounts agree with cash books and that purchase and sales ledgers are correct
  • If there are differences, highlight them and explain the circumstances
  • Keep all working papers – for example, VAT workings for quarterly returns. The same goes for PAYE and National Insurance payments
  • Consider work-in-progress. This is particularly important for professional firms in service industries, and where long-term contracts are involved
  • Highlight any particular problems or areas of incomplete information you may foresee
  • Discuss areas that the auditor may review while conducting the audit: for example, time recording, credit control, the accurate recharging of disbursements, efficient staff remuneration and suppliers’ rates