Unaudited financials

What Are Unaudited Financials?

Unaudited financials are financial statements that have not been subjected to an independent audit by a certified public accountant (CPA). These statements, which fall under the broader category of financial reporting, are prepared by a company's internal accounting staff or external bookkeepers without an auditor's verification of their accuracy, completeness, or adherence to established accounting standards.

Unlike audited statements, unaudited financials do not carry an auditor's opinion or a statement of assurance regarding their fairness or freedom from material misstatement. Despite this lack of external review, unaudited financials are commonly used for various internal purposes and, in specific circumstances, for external stakeholders. These documents, like all financial statements, typically include a balance sheet, income statement, and statement of cash flow.

History and Origin

The distinction between audited and unaudited financial statements emerged alongside the formalization of accounting practices and the rise of capital markets. Before the early 20th century, financial disclosures were often less standardized and external audits were not universally mandated. However, major financial events and a growing need for investor protection led to significant regulatory changes. In the United States, pivotal legislation like the Securities Exchange Act of 1934 played a crucial role in shaping modern financial reporting by mandating regular and audited financial disclosures for publicly traded companies. This act, established after the stock market crash of 1929, aimed to increase transparency and protect investors by requiring companies to file periodic reports with the Securities and Exchange Commission (SEC), which included audited annual financial statements.¹¹, ¹², ¹³, ¹⁴, ¹⁵ The requirement for independent audits for public companies inherently created the category of "unaudited" statements for those not subject to such mandates or for interim reporting.

Key Takeaways

• Unaudited financials are internal financial statements not reviewed by an independent auditor.
• They do not offer an auditor's opinion on accuracy, completeness, or compliance with accounting standards.
• Unaudited financials are typically used for internal management, early-stage funding, and private transactions.
• While they offer cost and time savings, they carry higher investor risk due to the lack of independent verification.
• Publicly traded companies often file unaudited financial statements for quarterly reports with regulatory bodies.

Interpreting Unaudited Financials

Interpreting unaudited financials requires a heightened degree of skepticism and caution compared to analyzing audited statements. Since these documents have not been independently verified, users must recognize the inherent limitations and potential for error or even intentional material misstatement. When reviewing unaudited financials, it is prudent to focus on major trends and ratios rather than precise figures. Look for consistency in reporting over time and understand the underlying assumptions and accounting standards the company claims to follow.

For internal management, unaudited financials provide timely insights into operational performance and financial health, enabling quick decision-making. However, for external parties, the absence of an audit means there's no independent confirmation that the financial data accurately reflects the company's true condition. Therefore, relying solely on unaudited statements for significant decisions, particularly those involving substantial investment or lending, is generally not advisable without additional due diligence.

Hypothetical Example

Consider "InnovateTech Solutions," a rapidly growing startup funding technology company seeking a seed round of financing. To provide potential investors with a snapshot of its recent performance, InnovateTech's finance team prepares a set of unaudited financials for the past six months, including an income statement and a balance sheet.

The income statement shows robust revenue growth and a shrinking net loss, while the balance sheet indicates increasing cash reserves from recent sales and early customer payments. Because InnovateTech is a private entity and the investment is an early-stage private placement, a full external audit, which can be time-consuming and expensive, is not practical at this stage.

A prospective venture capital firm reviews these unaudited financials. They note the positive trends but, recognizing the "unaudited" status, also request access to InnovateTech's bank statements, customer contracts, and other supporting documentation for a limited review. This allows the investors to corroborate key figures and gain a greater degree of confidence in the presented data, mitigating some of the risk associated with relying on unverified information.

Practical Applications

Unaudited financials serve several important practical applications, particularly for private companies, small businesses, and for interim reporting by public entities.

• Internal Management and Decision-Making: Companies frequently use unaudited financials for day-to-day operations, budgeting, forecasting, and performance monitoring. These statements can be prepared quickly, providing timely information for management to assess current financial health and make informed strategic and operational decisions.
• Early-Stage Funding and Private Placements: Startups and private companies seeking initial capital from angel investors, venture capital firms, or private equity funds often provide unaudited financials. These investors may conduct their own limited due diligence or rely on representations from management, as a full audit might be disproportionately costly or time-consuming at this stage. The New York Times has noted that small businesses often present unaudited financial data to investors when seeking capital.¹⁰
• Mergers and Acquisitions (M&A) of Private Companies: In the initial stages of mergers and acquisitions involving private businesses, buyers often review unaudited financials to assess a target company's financial standing before committing to a full audit as part of the deeper due diligence process.
• Interim Financial Reporting for Public Companies: Publicly traded companies in the U.S. are required to file quarterly reports (Form 10-Q) with the SEC, which include unaudited financial statements. These interim reports provide a continuous view of a company's financial position throughout the fiscal year, though they are not subjected to the same rigorous audit as the annual Form 10-K.⁸, ⁹
• Loan Applications for Small Businesses: Banks and lenders may accept unaudited financials from small businesses for smaller loan amounts, especially if the business has a strong banking relationship and a solid credit history.

Limitations and Criticisms

The primary limitation of unaudited financials stems from the absence of an independent auditor's review. This lack of scrutiny means they come with several inherent risks and criticisms:

• Lack of Assurance: Without an audit, there is no independent professional opinion stating that the financial statements are presented fairly, in all material respects, in accordance with applicable accounting principles. This significantly increases investor risk for external parties relying on them.
• Potential for Errors and Omissions: Unaudited financials are more susceptible to unintentional accounting errors, omissions, or miscalculations. Management may not have the expertise or internal controls to catch all discrepancies.
• Increased Risk of Fraud: The absence of an external audit removes a critical layer of oversight that helps deter and detect fraudulent financial reporting. Dishonest management could intentionally manipulate figures without immediate detection.
• Limited Reliability for External Parties: Lenders, investors, and potential acquirers generally place less reliance on unaudited statements for significant decisions. They often require additional due diligence, such as a review or full audit, to gain confidence in the financial data. Deloitte emphasizes that audited financial statements provide credibility and reliability, highlighting the inherent limitations of unaudited information.⁷
• Lower Credibility: Businesses that consistently use unaudited financials for external purposes, when an audit might reasonably be expected, may be perceived as less credible or transparent. This can hinder efforts to secure financing, attract investors, or engage in partnerships requiring a high degree of transparency.
• Absence of Internal Control Assessment: An audit also typically involves an assessment of a company's internal controls over financial reporting. Without this, weaknesses in a company's accounting processes may go undetected, increasing future financial risks.
• Difficulty in Compliance: While smaller, private companies might not be legally required to have audits, the lack of robust accounting practices that an audit encourages can make it harder for them to scale or comply with more stringent financial reporting requirements if they grow or seek public funding.

Unaudited Financials vs. Audited Financials

The key distinction between unaudited financials and audited financials lies in the level of independent assurance provided.

Unaudited financials are prepared solely by the company's management, reflecting their internal records and accounting practices. Audited financials, by contrast, have been examined by an independent third-party auditor who assesses whether the statements are presented fairly in accordance with applicable accounting standards. This rigorous examination and the subsequent auditor's opinion provide a higher level of reliability and trustworthiness for investors, lenders, and other external stakeholders.

FAQs

What does "unaudited" mean in finance?

"Unaudited" in finance means that financial statements have been prepared by a company's management without being subjected to an independent examination and verification by a certified public accountant (CPA). There is no external opinion on their accuracy or compliance with accounting standards.

Why do companies use unaudited financials?

Companies, especially private or small businesses, use unaudited financials for several reasons: they are quicker and less expensive to produce, provide timely data for internal decision-making, and may be sufficient for early-stage startup funding or small loan applications where a full audit is not required or feasible. Publicly traded companies also use unaudited financials for quarterly reports.

Are unaudited financials reliable?

While unaudited financials can be reliable for internal use, their reliability for external parties is limited. They do not carry the independent assurance that comes with an audit, meaning there's a higher risk of errors, omissions, or even intentional misrepresentations going undetected. External users, such as investors and lenders, often require additional verification or a full audit for significant transactions.

Can unaudited financials be used for investment decisions?

Using unaudited financials for significant investment decisions carries considerable investor risk. While they may offer an initial glimpse into a company's performance, savvy investors or financial institutions typically require audited financials or conduct thorough due diligence to verify the information before committing substantial capital.

Do public companies file unaudited financials?

Yes, public companies in the U.S. are required to file unaudited quarterly financial statements with the Securities and Exchange Commission (SEC) through Form 10-Q. These quarterly reports provide ongoing financial updates between the annual audited reports (Form 10-K).¹², ³⁴⁵, ⁶