Internal vs. External Audits: What’s the Difference?

Let’s face it, the word “audit” can sound intimidating, especially if you’ve never been through one before. 

But audits aren’t just about finding mistakes and compliance errors. They’re also incredibly useful tools to help you ensure accuracy in all your financial statements. 

They can identify inefficiencies that are costing your company money, as well as strengthen your credibility with investors and partners.

When conducted well, regular audits provide your company with benchmarks and a greater sense of control, allowing you to catch small issues before they escalate into costly problems further down the line.

However, not all audits are the same. There are two main types to be aware of: internal and external. Understanding how they differ and what each requires will help you get prepared and make the most out of the process. 

What Are Internal Audits?

Internal audits are in-house reviews of your company’s processes, financials and systems. They are conducted with the goal of evaluating your business in order to make it more efficient, compliant and profitable.

Internal audits are not required by law. However, they are considered best practice for most businesses, and it is a good idea to conduct them on a regular basis to ensure that your operations are on the right track. 

They can also help ensure that you’re remaining compliant and consistent with your current policies and processes, giving you greater oversight and peace of mind.

Who Conducts Internal Audits?

Larger companies tend to use their own internal accounting team or dedicated internal auditor to conduct regular internal audits.

For small to medium-sized businesses that lack the resources to hire a full-time accountant or auditor, outsourcing the job to a fractional accounting service can be a convenient, cost-effective choice.

What Do Internal Audits Focus On?

Internal audits can focus on a variety of key areas, including:

• Accuracy of financial records
• Compliance with internal policies
• Operational efficiency
• Effectiveness of current policies and processes
• Detection of errors or fraud

How Often Should Internal Audits Take Place?

As you are the one in charge of conducting them, internal audits can take place as frequently as necessary. For many businesses, the frequency will depend on the current growth stage and industry. Many businesses opt for either quarterly or annual reviews.

Why Are Internal Audits Valuable?

Internal audits come with a lot of benefits, giving you plenty of information to help you assess your current processes, identify specific problems and implement effective solutions.

Furthermore, an internal audit report can help identify potential risk areas and support smarter decision-making to minimize negative consequences.

Internal audits can help your company ensure compliance with policies and procedures while also verifying the accuracy of financial statements. This can help you avoid costly penalties during an upcoming external audit.

What Are the Potential Challenges of Internal Audits?

While internal audits can give you a lot of valuable information, they can also come with a few challenges to be aware of.

For one, internal audits cost money, potentially thousands of dollars each time one is conducted. They also require a significant time investment on the part of staff and partners. For small businesses operating on an already limited budget, balancing their usefulness with their cost is a tradeoff to consider.

As well, audits can be stressful. Employees may feel that they’re being overly judged or scrutinized, and day-to-day operations may slow down in favor of the audit.

What Are External Audits?

External audits are conducted by a third party to take a look at how well you are complying with rules and regulations. They also want to verify the accuracy of your financial statements, reports and records.

It’s important to note that private companies are not required to go through external audits unless they are required to do so by their industry. 

Only publicly-traded companies, or companies who are planning to go public, are required to be externally audited, as they must make their financial statements publicly available for investors. Nonprofits also must be externally audited in order to retain their status.

Who Conducts External Audits?

External audits are conducted by independent certified public accountants (CPAs), or by public accounting firms. To ensure objectivity, the auditor must be a third party with no ties to your company, providing an unbiased and credible assessment.

What Do External Audits Focus On?

External auditors will take a look at your financial statements and reports, focusing on a few key areas, including:

• Verifying the accuracy of your financial statements
• Identifying misstatements due to errors or fraud
• Ensuring that you’re complying fully with standards, rules and regulations

How Often Do External Audits Take Place?

External audits are typically annual, matching up with financial reporting cycles. However, certain industries may be required to conduct audits more frequently to comply with regulations.

Why Are External Audits Valuable?

External audits can be very beneficial to your company. 

For one, you’ll be able to prove that you’re complying with all regulations and that all your financial statements are in order. 

This solid proof by a third party that you’re running your company with transparency and honesty is very reassuring to lenders and partners, helping them feel confident that they can continue to support you well into the future.

Moreover, knowing you’ll undergo an external audit can help your business stay on top of things year-round. Establishing strong policies and maintaining financial discipline keeps your operations running efficiently, not just when an audit is looming.

What Are the Potential Challenges of External Audits?

External audits are required by law, so there’s no sidestepping them. However, it’s important to prepare properly for them to avoid any potential drawbacks.

As with internal audits, external audits come with a hefty price tag. In 2020, the average publicly traded company paid $2.53 million to have an audit conducted, and even nonprofits can expect to pay thousands of dollars.

Moreover, external audits can unearth compliance issues. 

If your company is compliant with industry and federal regulations, audits shouldn’t be a concern. However, if your audit turns up a lot of missing data, it could damage your credibility with investors and customers.

Final Thoughts

Audits are an important part of running a business, no matter how big your operations are or what stage of growth you’re in. 

While internal audits help keep your systems in check and improve your operational efficiency, external audits enhance your company’s credibility, reinforce the trust of investors and partners.

If you need help with preparing for an audit or improving your compliance, consider outsourcing the job to a fractional accountant service like Finvisor.

Our fractional back office solutions integrate seamlessly with small to medium-sized businesses just like yours, ensuring that you’ll be ready for your next audit.

To learn more about how we can help your business, get in touch with our team today and schedule a free introductory call.