Over the past seven months, the cannabis industry has seen a substantial uptick in investment, access to debt, and M&A activities. And while it is inspiring to see a flood of new money coming into the industry, it often comes with some pain for which cannabis companies are traditionally unprepared. This pain occurs in the form of due diligence. Rebel Rock is on the front lines of the due diligence march, regularly helping our clients with audit and review readiness. But what do those terms mean? And what is the difference between a compilation and standard financial statement preparation? The distinctions can be somewhat convoluted, but incredibly important.
What is an audit?
A financial statement audit is intended to provide the highest level of assurance to shareholders, lenders, and other interested parties that the information contained in the financial statements is free from material misstatement. Audits must be carried out by a CPA and also test the effectiveness of the internal controls around financial reporting. Through this process, the auditor can develop an opinion about whether the financial statements and related controls, provide a fair presentation of the company’s financial position. This opinion will be documented in the audit report, which accompanies the related financial statements.
An audit can be elective or imposed, depending on the nature of the business and relevant stakeholders. For instance, public companies (i.e., those listed on the US stock exchange) must necessarily subject their financial statements to audit on a quarterly and annual basis. By contrast, private companies have no such regulatory requirements. However, if a company seeks commercial debt, for instance, the bank may require an annual audit to provide a loan. Indeed, a company may elect to undergo an audit to give more confidence in the integrity of the company’s financial reporting.
What is a review?
A review is similar to an audit. It is carried out by a CPA and intended to provide some level of assurance regarding the presentation of a company’s financial position. However, where an audit report will state an affirmative opinion regarding the accuracy of the financials, a review provides only limited assurance that the CPA did not find evidence of material misstatement within the financial reporting. A review consists of substantially less overall testing and relies more heavily on the representations of management. For instance, the effectiveness of internal controls is not assessed when performing a review.
In both instances, it should be noted that, although the CPA is providing some level of assurance to relevant parties, executive management of the company itself is still ultimately responsible for the information reported in their financials. In both instances, it should be noted that the CPA performing the audit or review procedures must be independent. That means the CPA cannot be involved in preparing any of the information that goes into the financial statements under examination.
What is a compilation?
The purpose of a compilation is to allow a CPA to assist a company with its financial reporting. In a compilation, no assurance is provided over the accuracy of the numbers being compiled. The CPA relies solely on the representations of management and performs no testing over the resulting financial report. While a CPA must be independent when performing audit or review procedures, this same independence is not required for compilation engagements.
Why do I need an audit, review, or compilation?
Excluding the obvious requirement for public companies, a private company may be required to subject their financials to audit or review in connection with a funding event such as a commercial loan. However, audits and reviews can also make the due diligence process of ANY funding event go much smoother. In particular, most savvy investors understand the value of an audit or review opinion. Understanding the methods utilized by the CPA to gain confidence through their testing will give the investor confidence in the resulting opinion and numbers. The investor may require substantially fewer deliverables during due diligence because of the assurance already provided by the auditor or reviewer. This means less work for the business owner!
Further – audits, in particular, can be beneficial in identifying weaknesses in internal controls. Where weaknesses are identified, management can actively change procedures to ensure misstatements to the financials do not occur due to error or fraud.
By contrast, a compilation is typically useful when management is having a hard time determining how to record their financials on the proper basis of accounting or maybe generally lacks the accounting sophistication to create effective financial reporting altogether.
What will this cost me?
If you are wondering whether you need an audit, review, or compilation, it is imperative to weigh the cost against the benefit. In some cases, a business owner may have no choice to comply with the necessary covenants of their funding sources. However, when that is not the case, it is important to note that audits are generally costly. On the lowest end, they are likely in the range of $25,000 to $50,000.
A review is generally somewhat less expensive but will likely still come with a price tag in the tens of thousands.
The compilation cost will vary substantially on how much assistance the business owner needs. It should come as no surprise that more assistance will usually translate to more expense.
What can I do to prepare?
One of the biggest reasons that audits, reviews, and compilations can skyrocket in cost is the lack of preparedness on the part of the company under examination. If you are not sure what is needed to achieve a clean opinion from your audit or review, speak to a professional CPA, like those at Rebel Rock, with a background in audit to get an understanding of the overall process and deliverables. Also, if you are planning to solicit funding of any type, the time for that conversation is now. You do not want to wait until you are engaged in due diligence with an investor to need audited financials. This can substantially delay or even eliminate funding, as you will seem just as unprepared to your interested investor.