How to choose your first Financial Auditor?
So you need to get an audit?
Your company has hit the stage where you are either thinking about getting a financial audit or an external stakeholder is requiring you to get one. The importance of this decision should not be taken lightly. The firm you choose will be a strategic advisor to your finance and accounting team and will likely remain your auditor for years. They will serve as an extension of your accounting team, and this decision should be treated with the same level of rigor as a hiring decision.
Note — if you are not required to get an audit, or if those requiring one of you (e.g. investors) can be talked off the ledge on this, do not go through with one. The costs of an audit almost always outweighs the benefit. Think about getting a review instead to gain confidence over your numbers without the burden of a full-fledged audit.
So how to pick your auditor?
Audit firms are classified into three buckets: Big Four, Mid-Tier, and Local. The first step is to understand the different types of audit firms and which best suits your company’s needs. Below I’ll break down the Pros and Cons of going with a firm in each of these three buckets.
Big Four — Deloitte, PwC, EY, and KPMG
Big Four Pros:
Name recognition — this can go a long way with your investors, creditors, regulators, and any other or future stakeholders. All of these stakeholders mentioned above know how reputable these four firms are. An audit opinion from any of these carry a lot of weight.
No need to switch auditors if you scale — if you want to become a public company, you’ll likely need to get an audit from a Big Four firm. 99.7% of the S&P 500 are audited by a Big Four firm. Switching costs are incredibly high with audit firms, and so being able to stay with one firm is a huge bonus to your future accounting team.
Confidence in your numbers — you can be confident that your financial reporting is accurate as they are audited by the best. These firms can also provide better advice and can better help you scale your operations. They audit successful companies, which means that they can provide insight into what these companies did. This credibility can go a long way in your future decision-making.
Fees can actually be lower — contrary to what you may think, first year audits by a Big Four firm are likely cheaper than any other firms. This is because of their business model of getting their foot in the door. Audits have extremely high switching costs, therefore, it is likely that they will continue being your auditor through the IPO. If the Company IPOs, they will more than make up for losses on your early engagements. Smaller firms cannot play this game because in all likelihood, the company will switch to a Big Four firm prior to an IPO. When pricing, all the firms across all three categories of firm understand this market dynamic.
Big Four Cons:
They are intense — this piece should not be understated. A Big Four audit will require much more time than audits from lower tier firms. This is because the firms built their auditing methodology with large enterprises in mind. They have to keep this same framework for smaller engagements. These larger companies have accounting teams of 10+ with highly technical and experienced accountants on board and even those companies struggle to get through Big Four audits.
High risk of non-completion — while the firms will never tell you this up front, the likelihood of completion of a first year audit within 6 months is rare. They won’t tell you this because they want your business. Most first year audits will take greater than 1 year to be completed. That is 1 year from the start of the engagement, which already starts many months after the year ended. This is especially the case if you don’t have experienced accountants in place and/or your business is complex with several complex transactions.
Less attention and lack of scheduling flexibility — The Big Four firms have more important clients than yours. Unless you’re paying the firm millions of dollars (you can see how much public companies pay their auditors by looking at the company’s public filings, and the fees are typically in the millions), they have other higher priority clients. During the period of January through April, there is little chance that they will be able to staff your engagement because they will be focused on public company audits during this time period. This limits the window of time for your audit. If you get to January and the audit is still not completed, then you’ll need to wait several months before it gets picked up again.
Conclusion: You should go with a Big Four firm if you meet any of the following:
You are required to by regulators, creditors, or other stakeholders. In these cases, you have no choice anyways.
You are 100% confident that you’ll be able to pass. You have a simple business model and have the appropriate accounting staff.
You are willing to spend money to consultants to help (note this will be costly).
If you do not meet any of the above, I’d recommend considering other firms below.
Mid-Tier — Grant Thornton, BDO, RSM, or any from the top 20 firms (outside the Big Four)
https://insidepublicaccounting.com/ipa-top-500-firms/
Mid-Tier Pros:
These firms are also reputable — just because they don’t have the recognizable Big Four name, they are still extremely reputable firms. In certain cases, firms on this listing have a bigger presence in local markets than the Big Four have in the market. For example, Moss Adams is more reputable in Seattle and surrounding cities than some of the Big Four.
Intensity is lower than the Big Four — this means that passing the audits are more likely than when going with a Big Four firm.
You may not need to switch auditors before going public — there are still many companies going through an IPO with non-Big Four firms as their auditors. While a Big Four audit is essentially required for companies in the S&P 500, it is not for smaller public companies.
These firms are hungrier to keep your business — these firms have a chip on their shoulder constantly losing business to their Big Four overlords. Thus, they are likely to do what it takes to keep your business, and to provide more attention to your company’s needs.
Mid-Tier Cons:
Still not as reputable as a Big Four firm — the day will likely never come where an audit opinion from a non-Big Four firm will hold more weight than a Big Four audit opinion. This is just one of the laws of the accounting universe.
The audits are still fairly intense — just because the audit is not a Big Four audit, does not mean that it will be easy and have a 100% chance of passing. These firms uphold high standards for their audits, and do not sacrifice on these standards.
May need to switch to Big Four in the future — although as stated above it’s possible to go public with one of these firms, it is unlikely if it is a large company filing. In 2023, only 34% of companies that went public had a Big Four auditor, however, the Big Four audits comprised 94% of the proceeds!
Conclusion: These firms are good to go with if you are a medium-growth company and do not have any ambitions of going public in the next few years. The audit opinion carries good weight with regulators, creditors and investors, while being easier to pass.
Local Firms — any of the firms rated 21 through 500 (anything over 500 may be too risky)
Local Pros:
The audit is much easier to pass — these firms likely do not audit public companies and have never had to go in front of the Public Company Accounting Oversight Board (PCAOB) or the Securities and Exchange Commission (SEC) regarding audit quality or technical accounting decisions. The bar to pass these audits overall is just lower.
Experience with these types of audits — these firms have lots of experience with first-year audits and auditing companies with small or no accounting teams. Whereas the Big Four firms mainly have experience with large enterprises, the smaller firms are used to the messiness that comes with auditing startups.
Performing of other services — these smaller firms can provide many other services to your business because they do not have the same internal independence requirements. They can help with tax returns, tax provision, accounting advisory, etc. The bigger firms often cannot provide these same services. Having one firm for all your accounting needs can be beneficial in pricing and company knowledge.
Local Cons:
Little to no name recognition — the smaller firms do not have the same level of name recognition, which could become a problem if a stakeholder requires an audit from a bigger firm (see high switching costs discussions above).
Leads to less incentive to fix broken processes — because the audits are easier to pass, companies are lead to believe that their accounting processes are fine as is. But just because the firm signed off on the financial statements, it doesn’t mean that the processes are correct or there are no material differences in your financials.
Lower quality of advice and technical accounting guidance — most of the talent in the accounting industry goes to larger firms. These are the same dynamics of any industry. With this, the accounting assistance could be of lower quality, resulting in changes required in the future. That said, I understand that this is over generalizing, and there are super strong individuals at the smaller firms.
Conclusion: If audit quality isn’t your top priority, opting for a smaller firm might be a practical choice. If there’s no specific requirement for which audit firm to use, and you’re focused on completing the process efficiently, a local firm could be the right fit for your needs.
Conclusion on Type of Firm to Choose
As shown above, there is a lot that goes into making this decision. Every company is unique and has unique circumstances. Therefore, I will not be providing an overall best type of firm to go with. The decision should reside on the facts and circumstances of your business and which option above meets your requirements.
Choosing the Audit Firm itself
Now that you’ve made a choice on the type of firm to go with, how do you decide on the actual firm itself?
RFP Process:
Send out Requests For Proposals (RFP) to several of the firms within the bucket you choose. It is recommended that you reach out to several in other buckets to assess the differences for yourself. Similar to making any important decision in business and in life, having multiple options is always beneficial.
In addition to having multiple options to choose from, it also provides you with pricing power over the firm you end up deciding on. Through the pricing negotiations, you can use the other firm’s price as leverage.
You can generally find the RFP by looking at the audit firm’s website and completing the forms.
Important Questions to ask prospective audit firm:
What comparable companies do you audit? This is such an important question because the firm will leverage their work on other clients in tackling your audit. Every industry is different and comes with their own intricacies and complexities. This means that the more experience a firm has with similar companies, the easier the audit will be on both sides. They also will be able to provide more precise and relevant guidance.
In those audits of comparable companies, what are the most complex areas? This question will allow you to dig deeper into their knowledge and expertise in your industry. You know your company best, and if the complexities they identify do not resonate with the challenges at your company, they likely don’t actually have the right experience for you.
How has the staffing at the firm been, and do you know who would be on the engagement team? It’s very important that the firm has the right staffing, as the people on the team will make or break the audit.
How many first year audits have you completed within one year? Really drill into this question. They may hedge their response by saying that it’s confidential, but it’s still a good question to ask. You want to have some assurance that the audit will be completed within one year.
What are the fees and can we lock in rates for the next couple years? Obviously the fees are very important, and you need to discuss these to compare against other firms. Also, locking in rates now will be helpful later down the road. The firms know about the high switching costs. With this knowledge, the firms could overcharge you in the year 2–3 and beyond.
Are there any other fees and what is the probability of overages? The firms like to charge for additional fees such as “technology fees”, which are on top of the engagement letter fee. Ensure you’re aware of these fees and understand what additional you could be charged. Further, the firms will internally come up with an estimate of hours for the engagement. If the actual hours are significantly higher (which they almost always are for first year audits), then they’ll try to charge overages. Ensure you’re aware of the budgeted hours so you’re not surprised when they try to charge you overages.
Making the Audit Firm choice
You’ve gathered audit proposals from several firms, and they’ve all given you their standard sales presentation. And now it’s time to make your decision…
Overall, I believe that the audit partner is the most important consultant you will have for your accounting organization full stop. They will be your go-to on technical accounting questions and how to account for new transactions. And, of course, they will be the one signing the audit opinion at the end of the day. They will be an extension of your team, and so make the decision as if it was a hiring decision. People talk about the importance of hiring the right people, and you should take this same approach with your auditor decision.
Conclusion
I hope this article helps you make an informed decision on which audit firm to choose. This is an extremely important decision, one that will impact you and your accounting team for years to come.
And once you’ve made your decision, now the real fun will start!
