In most growing enterprises, accounting got considered as a backroom job with sales, product and customers being in the focus. It’s all good until the business needs to raise capital, get a statutory audit, or answer a due diligence letter, and then the books are a real problem. These are almost invariably times when businesses that formed good accounting practices early – and well before an audit came calling – have performed well. Here are the requirements of audit-ready books, from the beginning of a business.
Separate Business and Personal Finances Immediately
This may seem like common sense, but it is one of the most frequent pitfalls for the early-stage entrepreneur, especially if they are using a proprietorship or small LLP and personal and business spending can be easily confused. All businesses, no matter how small, should have a business bank account from the start and all business money will come in and out of that account. When personal and business transactions are mixed, it can lead to reconciliation issues later and alert any auditor or diligence reviewer to the presence of personal transactions that are not clearly separated from the business transactions.
Choose the Right Accounting Software Early
For a small business that makes only a few transactions per month, it can seem like sufficient to use spreadsheet-based bookkeeping, but as transactions increase, maintaining the spreadsheet grows more difficult and manual errors increase. Even when it’s not truly required, the transition to proper accounting software early on and before it seems like it should be, ensures that the business will start with structured records that are exportable and much easier to review, reconcile and audit later.
It is more important that the software be used consistently from the beginning than the specific software itself. Laggard companies end up with a painful and time-consuming clean up process when they do eventually have to obtain audit-ready books, having to reconstruct months or years of transactions that should have been recorded systematically from the start.
Reconcile Accounts Monthly, Not Annually
A good indicator of audit readiness is the level of recon. Those businesses that reconcile monthly bank statements, vendor accounts and customer receivables will uncover discrepancies at a time when they can be easily solved and easily tracked. When businesses delay till year-end or even closer to an audit, they frequently discover that the issues they have to deal with have built up over the many months, making it far more time consuming and costly to tidy up the problems at the end.
Monthly reconciliation is also applicable to GST returns and TDS returns to ensure that the information reported to the tax authorities is in line with what is shown in the books. Departmental notices and audit queries are often caused by the mismatching of statutory filings and/or internal records, and it is best to avoid those mismatches by having a monthly discipline.
Maintain Supporting Documentation for Every Transaction
Documentation is the key to audit readiness, not only for what’s written down. All expenses, revenue receipts and intercompany transfers should be accompanied by supporting documentation such as invoices, contracts, approval documentation, and payment confirmations which can be retrieved promptly on request. It is as difficult for businesses to find evidence to back up correct entries in the books as it is to determine if books are actually accurate, because if they are correct, the business must be able to present the supporting evidence to the auditor and the regulators.
This is much easier to maintain than maintaining physical files or have to sift through a lot of email attachments, especially as the number of transactions increase, with the use of a digital document management system, even a simple structured folder system linked to accounting periods.
Track Related-Party Transactions Separately
As businesses expand, transactions with related entities, be those group companies, promoter-owned or family members, tend to increase and these should be treated with special attention in connection to record keeping. It is essential that related-party transactions are identified and separately recorded from the beginning, including the commercial purpose and the pricing basis for each transaction, because this is always a focus point of the statutory audit and tax assessment.
If these are not tracked separately, companies can end up retracing steps for previous transactions months or years after the fact and it is much more difficult to do it correctly at that time than subsequently.
Build a Consistent Chart of Accounts
An appropriate chart of accounts that is established with thoughtfulness before one is added on, and not just pulled out of the air, is much easier to understand and audit. As slowly over the years different kinds of accounts are established without a coherent plan or pattern, the financial statements of these businesses may require extensive reclassification efforts before they can be audited or reported to investors.
The chart of accounts will change over time, especially as the business moves from one line of business to another, as new revenue streams and cost categories are developed; it is important to review and refine the chart of accounts periodically so the underlying structure matches the business as it operates, rather than as it existed in another time period.
Prepare for Statutory Compliance Alongside Bookkeeping
The audit readiness process isn’t just about the accurate books, it’s about maintaining conformance alongside it. These include prompt filing of Goods and Services Tax (GST) and TDS, statutory registers of companies maintained and documents for any filing with the Registrar of Companies. Compliance and bookkeeping are two different functions that are rarely seen together within a business until a business audit or investor review for the first time.
Building the Habit Early Pays Off
Those companies that have been able to get through the fundraising, audit and due diligence processes without too much friction are invariably the ones that built accounting discipline as a habit and not a chore for after. Developing these practices from the outset, even if the volume of transactions is low and the audit seems far off, prevents a lot of time, expense and stress when that day does arrive.
For companies that are still in their infancy and desire to build solid accounting practices from the get-go, it is best to get professional advice in order to prepare systems that can expand easily with business growth. From the get-go, Anagha Consulting helps businesses to prepare for bookkeeping, compliance, and audits.