Getting your books ready for a financial audit or due diligence

If your company is raising a round, taking on debt, being acquired, or has been asked by an investor for audited financials, your books are about to be read by someone whose job is to find what is wrong with them.

Getting ready means four things. Your books have to be on the accrual basis and follow US GAAP. Every balance sheet account has to be reconciled and backed by a schedule. Revenue has to trace from contracts to invoices to cash. And your equity records, tax filings, and supporting documents have to be organized before the first request arrives. Most of the delay in an audit or a diligence process comes from information that exists but cannot be found, or numbers that cannot be explained. Both are fixable in advance.

Audits and due diligence ask different questions

The preparation overlaps, but the two processes are not the same, and it helps to know which one you are facing.

• Financial audit. An independent audit firm tests your financial statements and issues an opinion on whether they are fairly presented under GAAP. Lenders, larger investors, and some customers require one. An audit covers a full fiscal year and looks at your controls as well as your numbers.
• Financial due diligence. An investor or buyer, often working with an outside advisory firm, reviews your financials to decide whether to invest or acquire, and on what terms. The focus is on the quality of earnings: how much of your revenue and profit is recurring, how reliable it is, and what adjustments change the picture.
• Review engagement. A lighter option than an audit. An accounting firm performs analytical procedures and inquiries but does not test transactions in depth or issue an audit opinion. Some investors accept a review in place of an audit.

An audit asks whether your statements are accurate. Due diligence asks whether your business is what you said it is. Clean books answer the first question and make the second one much faster.

Your books need to be on the accrual basis

Auditors and most diligence teams expect GAAP financial statements, which means accrual accounting. Cash-basis books show when money moved, not when revenue was earned or costs were incurred, and they have to be converted before anyone can rely on them.

The conversion touches several areas that are easy to miss on the cash basis.

• Revenue recognition. Revenue is recognized as it is earned under ASC 606, not when customers pay. Annual contracts billed upfront create deferred revenue.
• Accrued and prepaid expenses. Costs are recorded in the month they relate to. Unbilled services become accrued expenses, and annual payments become prepaid assets.
• Leases. Office leases longer than 12 months go on the balance sheet under ASC 842.
• Stock-based compensation. Option grants are expensed over their vesting period, based on their fair value at grant.

If your company has been on the cash basis, the conversion usually has to be done for the full period under review, not just the current year. Starting it before an audit or term sheet is underway saves weeks.

Every balance sheet account needs a reconciliation and a schedule

Reviewers start with the balance sheet because errors there are harder to hide. For each account, they will ask what makes up the balance and how you know it is right.

• Cash. Bank and card accounts reconciled to statements for every month in the period, with no unexplained differences.
• Accounts receivable. An aging report that ties to the balance, with old balances reviewed for collectability.
• Prepaid expenses. A schedule of each prepaid item, its coverage period, and its remaining balance.
• Fixed assets. A register listing each asset, its cost, date placed in service, and accumulated depreciation.
• Accounts payable and accrued expenses. An aging of open bills and a list of accruals with the basis for each.
• Deferred revenue. A schedule by customer showing billed amounts, revenue recognized, and the remaining balance.
• Debt and convertible instruments. Loan statements, SAFEs, and convertible notes with their terms, balances, and accrued interest.

Suspense, clearing, and "uncategorized" accounts should be at zero. Any balance that cannot be explained becomes a question, and enough questions extend the timeline or reduce confidence in everything else.

Revenue gets the most scrutiny

Revenue is where reviewers spend the most time, because it drives valuation and is the easiest number to overstate.

• Contract support. For significant customers, expect to provide the signed contract or order form, the invoices issued, and evidence of payment.
• System to ledger. If you bill through Stripe or another platform, revenue in that system should reconcile to revenue in your books, month by month.
• Metrics to ledger. Any MRR, ARR, or bookings figure you have shared with investors should reconcile to recognized revenue. Gaps between a pitch deck number and the books are a common diligence finding.
• Concentration and churn. Diligence teams look at how much revenue comes from your largest customers and how much recurs from one period to the next.
• Unusual items. One-time deals, credits, refunds, and related-party revenue are separated from recurring revenue.

Equity records have to match the cap table

Every share, option, SAFE, and note on your cap table needs a matching record in your books and a signed document behind it.

• Issuances. Stock purchase agreements, board consents, and evidence of payment for each issuance.
• SAFEs and convertible notes. Signed agreements, with conversions recorded correctly when a priced round closes.
• Options. Grant agreements, board approvals, and 409A valuations supporting the exercise price, along with the stock-based compensation expense calculated from them.

If your cap table software, legal documents, and accounting records disagree, reconcile them before the review begins. Equity errors are among the slowest to fix because they often require board action or corrected filings.

Tax filings and compliance are part of the review

Diligence teams, and sometimes auditors, check whether your company has unpaid taxes, missed filings, or penalties that could become liabilities after the deal.

• Federal and state income tax. Filed returns for each year, with any extensions and payments.
• State registrations and franchise tax. Annual reports and franchise tax filings, such as Delaware's, kept current in every state where you are registered.
• Sales tax. An assessment of where your company has nexus and whether it is collecting and filing there.
• Payroll and contractors. Payroll tax filings and Forms 1099 for contractors paid during the year.
• International information returns. Foreign-owned US companies have reporting obligations such as Form 5472, and missed filings carry significant penalties.

Gaps found during diligence often become price adjustments, escrow holdbacks, or conditions to close. Finding and fixing them first gives you more control over the outcome.

Build the data room before anyone asks

A data room is a shared folder, usually in a secure file-sharing tool, that holds everything a reviewer will request. Building it in advance turns weeks of back-and-forth into a single handoff.

• Financial statements. Monthly and annual balance sheets, profit and loss statements, and cash flow statements for the period under review.
• Supporting schedules. Every reconciliation and schedule described above, exported at each period-end.
• General ledger and trial balance. Full exports for each period, so reviewers can test transactions themselves.
• Contracts. Customer agreements, major vendor contracts, leases, and loan documents.
• Corporate and equity documents. Formation documents, bylaws, board consents, the cap table, and equity agreements.
• Tax filings. Federal, state, and payroll returns, along with any notices received.

Name files consistently and keep one version of each document. A reviewer who finds two different versions of the same schedule will ask which one is correct.

Start before the request arrives

A first audit takes longer than later ones, because the audit firm also has to get comfortable with your opening balances from the prior year. Due diligence on a funding round or acquisition often runs on a deadline set by the other side. In both cases, the time you have is shorter than the time the cleanup can take.

A company whose books are on the accrual basis, reconciled and closed every month, starts from a strong position. Inkle closes books monthly and handles federal and state tax filings, so the reconciliations, schedules, and filing history a reviewer asks for already exist.

The bottom line

An audit or due diligence process does not create new problems in your books. It finds the ones that are already there. The companies that move through either process quickly are not the ones with perfect numbers, but the ones that can explain every balance and produce every document without searching for it. Accrual-basis books, monthly reconciliations, a cap table that matches the ledger, and current tax filings cover most of what any reviewer will ask. If you expect an audit or a raise in the next year, the best time to fix the gaps is before a deadline belongs to someone else.

Frequently asked questions

What is the difference between an audit and financial due diligence?

An audit is performed by an independent audit firm and ends with an opinion on whether your financial statements are fairly presented under GAAP. Financial due diligence is performed for an investor or buyer and focuses on the quality and sustainability of your revenue and earnings, to decide whether and on what terms to invest or acquire.

Do private companies need audited financial statements?

Not by law in most cases. Private companies usually need an audit because a lender, an investor, a large customer, or a pending acquisition requires one. Some investors accept a review engagement instead.

Can a company on the cash basis go through an audit?

An audit of GAAP financial statements requires accrual-basis accounting. A company on the cash basis has to convert its books to the accrual basis for the period being audited, which includes recording deferred revenue, accruals, prepaid expenses, and other adjustments.

How long does it take to get books ready for an audit?

It depends on how current and clean the books are. A company already on the accrual basis with monthly reconciliations may need only to organize schedules and documents. A company converting from the cash basis or catching up on months of bookkeeping will need considerably longer.

What documents should be in a due diligence data room?

Financial statements, general ledger and trial balance exports, account reconciliations and schedules, customer and vendor contracts, leases and loan documents, corporate and equity records including the cap table, and federal, state, and payroll tax filings.