Audited Financial Statements

Audited financial statements are a company's financial statements that have been independently examined by a certified public accountant, and that carry an auditor's report expressing an opinion on whether they fairly present the company's financial position and results in accordance with generally accepted accounting principles or another applicable framework.

An audit is far more than simply checking arithmetic. The auditor examines the company's internal controls, tests a sample of transactions against supporting documentation, confirms balances directly with banks and customers, and evaluates whether management's estimates and judgments — allowances for bad debts, inventory valuation, useful lives for depreciation — are reasonable and consistently applied. The goal is to provide reasonable, not absolute, assurance that the statements are free of material misstatement, whether caused by error or fraud.

A full audit is the highest level of assurance a CPA can provide; a compilation provides none at all, and a review provides limited assurance based mainly on analytical procedures and inquiry rather than the detailed testing an audit requires. Smaller companies without public shareholders or significant outside lenders sometimes opt for a review or compilation instead of a full audit, trading a lower cost for a lower level of assurance the numbers can be relied upon.

Publicly traded companies are legally required to have their annual financial statements audited before filing them with securities regulators. Private companies are typically required to provide audited statements when a lender's loan covenants demand it, when outside investors require it as a condition of financing, or when company bylaws or a shareholder agreement call for one. Nonprofit organizations above certain revenue thresholds are often required to provide audited statements to maintain grant eligibility or satisfy state charitable solicitation laws.

An unqualified, or “clean,” audit opinion is not a guarantee against fraud or future business failure; it is an opinion, based on testing a sample of transactions and evaluating management's representations, that the statements as a whole are fairly presented. High-profile corporate collapses that occurred shortly after a clean audit opinion was issued are a recurring reminder that an audit reduces, but cannot eliminate, the risk of material misstatement going undetected, which is why audited statements are generally trusted far more than unaudited ones, but are still read critically by sophisticated lenders and investors rather than taken purely on faith.

Audits are expensive relative to a compilation or review, since they require extensive testing, documentation, and sign-off by a licensed CPA firm, with fees scaling with a company's size and complexity. Many private companies weigh this cost directly against the benefit of a lower interest rate a lender may offer once audited statements are available, since lenders typically price risk lower when they can rely on independently verified numbers rather than management's own unaudited figures.

An audit opinion provides reasonable, not absolute, assurance that the financial statements are free of material misstatement — auditors test samples of transactions and controls rather than examining every single entry, and they are not guaranteeing the company's future success or protecting investors from an honest business failure. An unqualified, or “clean,” opinion is the best outcome a company can receive; a qualified opinion flags a specific, limited exception, while an adverse opinion or a disclaimer of opinion signals serious problems with either the numbers themselves or the auditor's ability to gather enough evidence to form a view at all. Investors reading a set of audited financial statements should always check which type of opinion was issued, since the opinion itself is often more informative than any single number in the statements.