There are many pejorative terms associated with the audit process – ‘just an overhead’, ‘a necessary evil, ‘a box-ticking exercise’ and so on. Understandably audit firms are therefore keen to talk nebulously about ‘added value’.
So can an audit really add value - and not in vague, abstract terms, but real, cash-impacting, money-in-your-back-pocket added value?
Well, that depends on the question you’re asking. If it’s “can an audit increase the underlying profitability of my business from year to year?” the answer is no, probably not, or, at least not very often. If the question is rephrased to “can an audit increase the equity value of my business?” or, more specifically “can a joined-up audit and advisory solution increase the equity value of my business?”, then the answer is yes, absolutely it can.
Well businesses are generally valued on an earnings multiple basis i.e. an annualised EBITDA figure (Earnings Before Interest & Tax) multiplied by a price to earnings (P/E) ratio, plus ‘free cash’. That figure forms the basis of an initial offer which is then negotiated, often downwards, to an agreed sale price. We call this phenomenon of downward negotiation ‘deal chip’, the extent of which bears a direct correlation to the buyer’s perception of risk. A pro-active, commercially focused advisor will be working with their clients to make them ‘exit ready’ by helping them to increase EBITDA, mitigate any perception of risk and increase the levels of free cash.
What does this look like in the real world?
1) Regular communication
The first, easiest, but often missed item is simply better communication – both in terms of frequency and quality of interaction. It’s astounding how few advisors are actually having the ‘exit planning’ conversation with their clients. This is often either a function of time or the inability or unwillingness to ask the right questions.
By meeting regularly with our clients and having the right kind of conversations, we’re in no doubt as to their long term ambitions. This allows us to align the audit process with those long term goals and turn it into a genuinely value-adding process.
2) Due diligence preparation
Ensuring that your business is properly prepared for a due diligence process, not only greatly reduces the stress of a business sale (you think moving house is stressful?!), but also delivers enhanced comfort and confidence to buyers, reducing the perception of risk and, ultimately, ‘deal-chip’.
How do we do this? Firstly, by making sure we do point one well, but secondly by working collegiately with our corporate finance colleagues to build an audit plan that, not only satisfies our regulatory requirements, but is thorough and commercially focused.
3) Value adding recommendations
How often does the auditor’s ‘management letter’ end up in the shredder or at the bottom of the drawer? We would say ‘too often’ when a management letter, or the implementation of the recommendations therein, can be a key aspect of a board’s quarterly strategic planning. Recommendations should not only cover off aspects relating to fraud and/or process (which are still important), but should be commercial and ‘value adding’, focusing on the following:
a) Internal Control/Corporate Governance – a strong internal control environment and a robust approach to corporate governance simply reduces the perception of risk to a prospective buyer, while simultaneously assuring the buyer that any ‘post-deal’ transition will be as seamless as possible.
b) Management Information – the weakness or strength of which has a major impact on perceived risk. By this we don’t simply mean an accurate set of accounts, we mean regular, comprehensive management information and an acute understanding of the business’ key profitability drivers. As well as being useful during a sale process, really great management information can be used to actively manage and drive improved business performance
c) Compliance – this may not be exciting but, in this context, is hugely important. A poor compliance record (or a poor attitude to compliance), particularly with regard to HM Revenue & Customs, will always increase the perception of risk to investors and acquirers.
d) Other matters - an audit team with their ‘radar’ attuned to the right things should be bringing to the attention of management those other matters than can affect risk and value – absence of key commercial contracts, over-reliance on key members of staff/customers/suppliers, gaps in management team etc etc
4) Financial reporting
Many accounting policies are choices, the results of which can vary greatly in terms of their impact on EBITDA and asset values. While an auditor can never replace or assume the function of management and select accounting policies or estimates on their behalf, it is the role of an advisor to challenge management’s assumptions and alert them to best practice, while ensuring that the financial statements continue to show a true and fair view and the independence of the auditors is never impaired.
5) Free cash
Finally, by working collegiately with colleagues from other specialisms, a joined-up audit and advisory solution has the ability to retain cash within the business (via effective VAT and tax planning strategies) and identify additional sources of cash flow (via grant and funding advice and effective treasury management).
Hopefully this gives you an understanding of what an audit can look like and an appreciation that an audit really can add value.