Independent financial audits help ensure the accuracy and reliability of a company’s financial statements. They prevent investors from being misinformed by fraudulent financial claims.

Independent auditors check financial data and examine business processes to provide an objective third-party opinion about the accuracy of the financial statements. As such, independent audits protect investors’ and shareholders’ interests and increase investor confidence in a company.

However, inaccurate financial statements hinder auditors from conducting effective financial audits. It puts the investors at risk. This article explores the importance of financial audits for investors.

Why are Financial Audits Important?

Companies usually prepare their financial statements according to prevailing accounting standards. The Accounting and Corporate Regulatory Authority (ACRA) issues these standards in Singapore. These financial statements contain information about the company’s financial performance and condition.

Many investors and stakeholders use these financial reports to make critical financial decisions. However, it is not enough for a company to claim that its financial statements are accurate. Investors and stakeholders have more trust in companies that undergo independent financial audits. This is because independent financial audits provide reasonable objective reassurance that the statements reflect the company’s financial position. Investors trust professional audit reports to verify that a company’s bookkeeping and accounting processes are credible and do not conceal any financial mismanagement.

Independent financial auditors examine management disclosures and financial statements like income/cash flow statements and balance sheets. They also review business processes and operations and provide professional recommendations on improving controls to improve business quality.

Consistent financial audits enhance investor confidence in the company’s operations. Regular financial audits with clean outcomes decrease the chances of fraud occurrence. It encourages existing investors to keep their investments and attracts new investors. Regular financial audits also increase business ratings. Investors are more likely to invest in a company with good ratings.

Role of Financial Audits in Investment Decision-Making

Investors and stakeholders often apply financial due diligence (FDD) to assess risks in an investment or business decision. Investors and stakeholders are strongly encouraged to do due diligence on a potential investment. It includes reviewing the company’s financial records and performance.

Financial audits serve as a due diligence tool for investors. They provide opinions that help the investor or stakeholder understand the company’s financial position and make an informed decision.

Auditors are qualified professionals who specialise in reviewing financial records and business controls. A 2020 study confirmed that audits by big four audit firms like KPMG are of higher quality than other firms. Auditors can identify red flags like accounting inconsistencies and assess the quality of corporate management processes. Audit reports contain comprehensive assessments of a company’s profitability and performance. As such, investors trust auditors’ opinions and often rely on audit reports to save time spent doing due diligence. Most investors begin the FDD process by looking through audit reports.

However, investors should not only depend on audits to make investment decisions. Good FDD requires personalised information on historical financial performance, risk identification, and future cash flow projections. FDD findings are usually customised to suit the individual needs and concerns of the investor. On the other hand, audit reports are conducted according to audit frameworks (GAAS – Generally Accepted Auditing Standards) and cater to broad audiences, including regulators and creditors. Audit reports may not cover specific areas of interest in detail. As such, investors should treat audits as a supplementary tool to enhance their due diligence process.

Importance of Accuracy and Reliability in Investment Financial Statements: Hyflux and KPMG Audit Episode

Auditor independence is essential for providing unbiased audit assessments. For an effective audit, auditors should not be influenced by internal control limitations, management override or other factors. Inaccurate financial information could also hamper the audit process and mislead investors, leading to potential investment losses.

One example of how inaccurate financial statements affected investors was the Hyflux and KPMG audit episode.

Due to financial issues, Hyflux, a Singapore-based water treatment firm, went into liquidation in 2021. KPMG was Hyflux’s auditor.

In 2022, Hyflux claimed that KPMG’s auditors had been negligent in auditing their 2011-2017 financial records. KPMG denied the allegations and argued in its defence that the obligation to prepare the financial statements in compliance with the law and reporting standards lies with the plaintiffs’ management and board.

Hyflux’s directors were charged in 2022 for failing to disclose crucial financial information about the Tuaspring Integrated Water and Power Project in their financial records.

Hyflux’s inaccurate financial statements had a part to play in the KPMG-Hyflux audit scandal. However, at the time of writing, the trial to determine the final legal verdict is still ongoing.

Conclusion

Financial audits safeguard investments by offering a professional opinion about the credibility of a company’s financial records and financial position.

Companies are responsible for ensuring clean audits by complying with professional accounting and reporting standards. They should disclose all necessary information to enable investors to make wise decisions.