3 Levels of Assurance – What is Right For Your Business?
Every business has financial statements, and when you (hopefully) begin discussions with a potential buyer, they will undoubtedly want to see them. The quality of those financial statements will make a big impression – what will your financial statements say about your business? And how confident can a potential buyer be that they are accurate? The more precise your financial statements, the lower the risk a potential buyer will associate with them, which can increase the value of your business. In general, an auditor can provide three levels of assurance on financial statements:
A compilation relies solely on the information provided by management. The accountant simply compiles the information received into a format that conforms with Generally Accepted Accounting Principles (GAAP) and provides no assurance that the data is free of material misstatement. Further, there are very few, if any, footnotes included in the financial statements. If the only level of assurance you have in your financial statements is a compilation, a potential buyer will likely view this as a risk. Any time there are risks present, it will affect the value of your business. A compilation is likely the cheapest, easiest route, but it could lead to issues down the road since it provides no assurance.
The next level of assurance that an accountant will provide is through a review. When using a review, the accountant will provide a limited level of assurance that the financial statements are free of material misstatement. When performing a review, the accountant will use specific procedures to identify unusual items in the financial statements and ask management about them. However, there is no responsibility to review internal procedures in detail. A review provides more assurance than a compilation, but there is still potential for error since there are items the accountant is not evaluating in this process. A potential buyer will feel better about reviewed financial statements versus compiled, but they likely will still want a bit more assurance that they are free of material misstatement.
The highest level of assurance comes from an audit where the accountant expresses an opinion that the financial statements are reasonably likely to be free of material misstatement and conform to Generally Accepted Accounting Principles. In addition, the auditor will perform various tests of internal controls and report on any “material weaknesses” uncovered during the audit. An audit is the only time the accountant will express an opinion on the financial statements. Because of this, audited financial statements are typically required in many business transactions.
Various levels of assurance may be appropriate for different companies, but in many cases, if there is a potential transaction involved, it will likely require audited financial statements where the accountant expresses an opinion. Despite the increased cost of an audit, it provides potential buyers with increased confidence during negotiations and the perception of lower risk. When the risk is reduced in a buyer’s eyes, the business’s value increases, which can go a long way in maximizing family wealth.
Matt is a wealth manager at BDF. He sits on BDF's Financial Planning Committee and leads many of the firm's tax-related initiatives. Matt has a passion for building strong relationships with his clients and helping them make sound decisions. He also holds the Certified Exit Planning Advisor designation which helps him advise business owners on how to exit their business and prepare for retirement.