Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Financial Audit====== A financial audit is an independent, professional examination of a company's [[financial statements]]. Think of it as a deep-dive health check-up for a company's books, performed not by the company itself, but by an impartial outsider—typically a [[certified public accountant (CPA)]] or a firm of them. The auditor's mission is to provide reasonable assurance that the financial reports—namely the [[income statement]], [[balance sheet]], and [[cash flow statement]]—are free from 'material misstatement'. In plain English, they check if the numbers are a fair and accurate representation of the company's performance and financial position, following established accounting rules like [[GAAP]] or [[IFRS]]. It’s not about catching every tiny error or hunting down every case of fraud (though they might uncover it). Instead, the audit provides a crucial layer of credibility, giving investors, lenders, and regulators confidence that the numbers they're relying on aren't just a work of fiction. Without a clean audit, a company's financial story is just an unverified tale. ===== Why Should a Value Investor Care? ===== This is the core of trust for a [[value investing]] practitioner. Value investors build their entire thesis on a company's fundamentals. You meticulously calculate ratios, project future earnings, and determine a company's [[intrinsic value]] based on the numbers it publishes. But what if those numbers are wrong? A financial audit is the mechanism that validates this foundational data. It's the difference between building your investment case on solid ground versus quicksand. A company that consistently receives clean audit reports is demonstrating a commitment to transparency and good governance. Conversely, audit-related problems are a giant, flashing red light. [[Warren Buffett]] famously said, "Accounting is the language of business." A financial audit is like having a professional linguist confirm the translation is accurate. ===== The Auditor's Report: Your Treasure Map ===== The final product of the audit is the [[auditor's report]], usually found in the company's [[annual report]]. Don't just skip to the numbers! This report is a goldmine of information. The most critical part is the auditor's opinion. ==== The Four Flavors of Opinion ==== Think of audit opinions like a restaurant review: * **Unqualified Opinion (The Five-Star Review):** Also known as a "clean opinion," this is the best possible outcome. An [[unqualified opinion]] means the auditor is satisfied that the financial statements are presented fairly in all material respects. This is what you want to see. Thumbs up! * **Qualified Opinion (The "Good, But..." Review):** This is a yellow flag. With a [[qualified opinion]], the auditor is //mostly// satisfied but has a specific reservation about one area of the accounts that is material but not pervasive. For example, they might disagree with the company's valuation of a particular asset but find the rest of the statements to be fine. It’s a call to dig deeper into that specific issue. * **Adverse Opinion (The "Don't Eat Here!" Review):** A massive red flag. An [[adverse opinion]] means the auditor has concluded that the financial statements are materially misstated and misleading. They do //not// represent the company's financial health fairly. If you see this, run. Seriously. * **Disclaimer of Opinion (The "Couldn't Get in the Kitchen" Review):** Another huge red flag. A [[disclaimer of opinion]] means the auditor was unable to gather enough evidence to form an opinion at all. This might be because the company's records are a complete mess or management blocked the auditor from doing their job. It signals a fundamental lack of transparency and control. ===== Reading Between the Lines ===== A savvy investor looks beyond just the final opinion. ==== Key Audit Matters (KAMs) ==== In Europe (and as "Critical Audit Matters" or CAMs in the US), auditors must now highlight the areas of the audit that were most challenging, subjective, or carried the highest risk of material misstatement. This is a gift to investors! [[Key Audit Matters (KAMs)]] point you directly to the company's financial pressure points. Is it the valuation of [[goodwill]] from an acquisition? Is it how they recognize revenue from complex contracts? Pay close attention to this section; it’s where the real story often lies. ==== Auditor Tenure & The Big Four ==== It’s also worth noting who the auditor is and how long they’ve been on the job. The vast majority of large public companies are audited by one of the "Big Four" accounting firms: [[PwC]], [[Deloitte]], [[EY]], and [[KPMG]]. While their brand brings a level of credibility, they are not infallible—just ask anyone who invested in companies like Wirecard or [[Enron]]. Also, consider auditor tenure. A long-standing relationship (e.g., 10+ years) could potentially lead to complacency, while a brand-new auditor might be more skeptical but could also miss historical context. It’s one more piece of the puzzle to consider.