Originally published in Equipment Finance Advisor

By Tobey Wilson 

There are many benefits to having your leasing company’s annual financial statements audited by a certified public accountant. Not only does an audit provide a higher level of assurance on a company’s financial statements, it can also help to improve internal policies and procedures, help to make sure the company has adequate checks and balances in place and, most importantly, increase the credibility, and therefore the value, of financial reporting to third parties such as funding sources and potential buyers.

Many equipment leasing companies fail to see the value in this service and often overlook it, but in my experience a good financial statement audit can be one of the most powerful business improvement tools in the industry and one that more leasing companies should be exploring.

Financial Statements for Equipment Leasing Companies Are Different

Equipment leasing companies have certain complex accounting requirements that lead to greater risk of misstatement. Due to this, the importance of audited financial statements is magnified in the eyes of funding sources, as they want reasonable assurance that the financial statements are free from material misstatement.

An audit not only provides assurance to funding sources, but also provides equipment leasing companies with a valuable review of their internal accounting policies and procedures to ensure they are recording transactions correctly. While it does come with a price tag, a financial statement audit can be a great learning opportunity and an investment in the company’s future.

Once the audit has been performed, the company will receive a letter addressed to those charged with governance listing any discrepancies noted during the audit and a letter explaining the scope of the audit procedures performed, significant findings, any auditor disagreements with management, as well as any audit adjustments and significant estimates that are not communicated in the audited financial statements. The letter will also present passed adjustments, which are adjustments that were not posted to the audited financial statements, because, in total, their effect is not material to the financial statements taken as a whole. These passed adjustments are presented to those charged with governance in order to bring attention to other known errors found during the audit, even though they were not considered material.

To me, a financial statement audit—and a long history of completing them year after year—offers three major benefits to leasing companies: added levels of assurance that a company’s financial reporting is sound; an easier path to future funding; and a more attractive financial history in the case of an acquisition offer.

All three of these can pay dividends down the road.

Additional Levels of Assurance

Financial statements are normally prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP), meaning the statements follow prescribed accounting rules that allow a reader to make general assumptions about how transactions are recorded and what account balances represent. If a company elects not to follow a particular GAAP rule in its reporting, the departure is required to be explained in the footnote disclosures so that the reader is aware and can consider the effects of the departure in analyzing the financial statements.

But that is only part of the process when it comes to assurances in financial reporting.

An audit goes a step further to provide the highest level of assurance to a reader of a company’s financial statements, as it includes inquiries of management, financial analysis and testing, as well as confirmation of material balances with third parties, where possible. Reviewed financial statements can only provide limited assurance, as the independent accountant analyzes the financial statement balances and compares them to prior periods, and also makes inquiries of management with regard to its accounting policies and procedures. Third party confirmations are not generally performed in a review engagement.

Improved Ability to Get Funding

In order to establish a line of credit, revolving note payable or long-term credit facility, one or more years of GAAP basis financial statements may be required by the funding source. On an ongoing basis, most banks and other funding sources will require a borrower to provide annual financial statements prepared in accordance with GAAP as part of their covenants, and some will require some advanced level of assurance provided by an independent certified public accountant.

One benefit of having your leasing company’s financial statements audited annually, then, is that it can provide access to greater and more diverse funding sources. If an equipment leasing company expects to hold its own portfolio and obtain funding from debt sources such as banks or other corporate investors, audited financial statements may be a necessity.

As credit limits increase, the required level of assurance can increase as well. Many lenders will likely move from compiled, to reviewed, to audited financial statements, with an audit providing the highest level of assurance on the financial statements.
Having several years of audited financial statements gives a company credibility and gives creditors a higher level of comfort in their business, which could result in more favorable credit limits and possibly lower interest rates, increasing a leasing company’s business potential while reducing its cost of capital.

What a Financial Statement Audit Does Not Provide

Audited financial statements include an opinion from an independent third-party accounting firm that expresses reasonable assurance that the company’s financial statements are free from material misstatement. An audit also includes a review of the company’s internal control in order to obtain an understanding of the company and the environment in which it operates, and to evaluate risks that could impact the financial statements. The auditors will use this information to identify potential fraud risks and indicate instances where internal fraud could occur within the company.

It is important to note that, while an audit includes reviewing internal controls, it is not designed to provide an opinion on how effective internal controls are, or to detect all instances of actual fraud that may have occurred. Still, despite this, auditors can be a source of valuable advice on how to set proper controls and help prevent fraud.

In evaluating internal controls, auditors concentrate on areas including proper authorization requirements, the safeguarding of assets and the segregation of duties. Based on the effectiveness of controls, the auditor determines the level of testing required in the audit.

The less effective the audit controls, the more extensive the audit procedures needed and the greater cost for the audit.

It is often the case with smaller companies that there are not enough personnel on staff to maintain an effective segregation of duties, resulting in an assessment of a high level of risk and a need for more extensive audit procedures. In these cases, an audit can be an extremely helpful tool in enhancing delegation and process optimization, thus helping to identify problem areas within the company.

The Ultimate Reward

Building a profitable, valuable portfolio with a well-run back office can pay off when it is time to sell the business. Annual financial statement audits can help make this a reality. A potential buyer will want a level of assurance that convinces them that they are making a good investment in buying a particular leasing company. Providing a history of audited financial statements sends the message that you have been diligent in your attempts to properly and accurately record the financial activity of the company, maintain proper accounting policies and procedures, and prevent the occurrence of fraud.

An annual financial statement audit can help provide this level of assurance to owners and investors throughout the life of the business, and provide assurance that will help to make your business a desirable investment to potential buyers.

Tobey Wilson, CPA, CLFP is a shareholder at ECS Financial Services, Inc.