Here's to Financial Clarity:

How to Conduct an Internal Audit

Like a Pro

Let’s be real—when most business owners hear the word “audit,” it ranks somewhere between “root canal” and “surprise IRS visit” on the list of Things We’d Rather Avoid. It conjures up images of cold conference rooms, stacks of paper taller than a toddler, and someone asking, “Can you explain this expense from three years ago?” in a tone that suggests you might be a criminal.

But here’s the good news: an internal audit is completely different. This isn’t about an outsider picking apart your books with a magnifying glass. This is your chance to take control of your finances, spot potential problems before they become disasters, and fine-tune your financial processes—all without an auditor breathing down your neck. Think of it as a financial deep-clean for your business, except instead of scrubbing floors, we’re scrubbing the numbers.

Trust us, an internal audit is a power move. Done right, it helps:
✅ Catch financial errors before they snowball into real problems
✅ Prevent fraud before someone in the office suddenly starts driving a sports car
✅ Improve cash flow so you’re not constantly asking, “Can we afford this right now?”
✅ Keep your records tax-season-ready, so there are zero surprises when it’s time to file

So, how do we pull this off without losing our sanity? That’s where this guide comes in. We’ll walk through a step-by-step process to review, refine, and reinforce your financials—giving you complete clarity and control over your business’s money.

Grab your coffee (or something stronger—we won’t judge), and let’s dive in. 🚀

Step 1: Define the Scope and Objectives

Before diving into the numbers, it’s essential to have a clear game plan—because "let’s just see what we find" is a terrible audit strategy (and a great way to spiral into financial chaos). A well-structured internal audit starts with defining what’s being reviewed, why it’s being reviewed, and what the goal is.

What’s Being Audited?

An internal audit doesn’t mean flipping through every receipt and transaction from the past decade (unless you have a love for financial punishment). Instead, the focus should be on key areas that impact financial health and business integrity. Common audit areas include:

• Financial Statements – Are the profit & loss statement, balance sheet, and cash flow reports accurate?
• Cash Flow & Bank Reconciliations – Do the books match what’s actually in the bank?
• Accounts Payable & Receivable – Are vendors being paid on time? Are outstanding invoices being collected?
• Payroll & Employee Expenses – Any phantom employees or expense report shenanigans?
• Tax Compliance – Are all filings accurate and deductions properly applied?
• Internal Controls & Fraud Prevention – Are proper checks and balances in place?

Depending on the business’s size and complexity, the audit might cover everything at once or focus on one area at a time. The key is prioritization—if cash flow has been tight or financial statements don’t seem to add up, that’s where to start.

Setting Audit Goals

A successful internal audit isn’t just about finding errors—it’s about improving financial accuracy, efficiency, and security. A clear objective keeps the audit focused and actionable. Some common goals include:

• Detecting & correcting errors – Identifying discrepancies in financial statements.
• Ensuring compliance – Following tax laws, payroll regulations, and GAAP best practices.
• Identifying financial risks – Spotting signs of fraud, cash flow issues, or overspending.
• Improving financial processes – Streamlining invoicing, expense tracking, or approval workflows.

Setting specific goals upfront helps prevent the audit from turning into a never-ending scavenger hunt for financial mysteries.

Determining Audit Frequency

How often should an internal audit be conducted? That depends on business size, industry, and complexity.

• Monthly or Quarterly: Ideal for businesses with high transaction volume or rapid growth.
• Annually: A full-scale review before tax season or financial planning sessions.
• As Needed: If fraud, financial irregularities, or major operational changes are suspected.

A proactive internal audit schedule helps catch and correct issues before they become expensive problems.

Step 2: Gather Financial Records and Documentation

Now that the audit’s scope is defined, it’s time to gather the financial records that will make or break the process. This step is all about ensuring that every number being reviewed is backed by clear, accurate documentation. After all, an audit without records is just guesswork—and that’s not exactly a winning financial strategy.

Essential Financial Documents Based on Audit Type

Not every internal audit requires the same set of records. Here’s a breakdown of key documents based on the type of financial audit being conducted:

• Financial Statement Audit (Ensuring accuracy in reporting)

• Profit & Loss Statement (P&L) – Are revenue and expenses recorded correctly?
• Balance Sheet – Do assets, liabilities, and equity accounts reconcile?
• Cash Flow Statement – Are cash inflows and outflows accurately categorized?
• Bank Statements & Reconciliations – Does the bank balance match accounting records?
• General Ledger – Reviewing all recorded transactions for accuracy.

• Cash Flow & Bank Reconciliation Audit (Making sure there’s no “phantom money” in the books)

• Bank Statements – Matching transactions against the ledger.
• Bank Reconciliation Reports – Identifying unrecorded transactions or timing discrepancies.
• Outstanding Deposits & Checks – Confirming all expected cash has cleared.
• Cash Flow Forecasts – Comparing projected vs. actual cash movements.

• Accounts Payable & Receivable Audit (Tracking what’s owed and what’s due)

• Invoices Sent (AR) & Received (AP) – Ensuring all transactions are documented.
• Accounts Receivable Aging Report – Identifying overdue client payments.
• Accounts Payable Aging Report – Checking for missed payments or outstanding vendor balances.
• Vendor & Customer Contracts – Verifying payment terms and obligations.

• Payroll & Employee Expense Audit (Because payroll errors can be costly!)

• Payroll Reports – Reviewing salaries, wages, and bonuses for accuracy.
• Tax Withholding & Benefits Documentation – Ensuring compliance with payroll tax laws.
• Employee Timekeeping & Attendance Records – Verifying payroll matches hours worked.
• Expense Reports & Reimbursements – Spotting excessive or unauthorized claims.

• Tax Compliance Audit (Avoiding unpleasant surprises from the IRS)

• Federal, State, & Local Tax Filings – Reviewing past tax returns for errors.
• Sales Tax Reports – Ensuring all applicable sales tax has been collected and remitted.
• Payroll Tax Filings – Verifying proper withholding and employer tax contributions.
• 1099s & W-2s – Checking contractor and employee classifications.

• Fraud & Internal Controls Audit (Identifying financial weak spots before they become disasters)

• Access & Approval Logs – Who has access to financial systems and who approves transactions?
• Expense Reports & Credit Card Statements – Looking for unauthorized purchases.
• Vendor & Payroll Records – Checking for fake employees or fraudulent vendors.
• Financial Statement Comparisons – Identifying unusual trends or unexplained discrepancies.

Best Practices for Organizing Financial Records

Collecting the records is one thing—keeping them organized is another. A chaotic pile of documents won’t help the audit process. Here are a few tips to keep things structured:

• Go Digital – If records are still in paper form, scan and store them in accounting software or a secure cloud system.
• Use Consistent Naming Conventions – Label files in a way that makes them easy to find (e.g., “Bank Statement - 2025-03-31” instead of “Scan_034”).
  Separate by Category – Keep bank records, tax documents, payroll files, and other financial records in distinct folders.
• Match Transactions with Supporting Documents – For every transaction reviewed, ensure there’s a corresponding receipt, invoice, or approval.
• Utilize Technology – There is a plethora of great apps to manage these capture and storage of documents. Find the right solution for your business and you can dispatch with this headache once and for all.

If financial records aren’t well-organized, this step may take longer—but it’s a crucial part of making future audits easier and ensuring financial transparency.

Step 3: Key Financial Statements to Review (And How to Analyze Them)

A financial statement audit focuses on three core reports: the Profit & Loss Statement, Balance Sheet, and Cash Flow Statement. Each report tells a different story about the business, but they must work together. If something doesn't add up, it's a sign that either an error exists or that deeper financial issues need to be addressed.

Profit & Loss Statement (P&L) – Are Revenue and Expenses Accurate?

The P&L statement (also called an income statement) shows how much money the business made (revenue), how much it spent (expenses), and whether it ended up with a profit or a loss.

How to Review the P&L Statement

• Start with Revenue (Sales Income)
• Compare revenue from this period to past periods. Are there any unexpected jumps or drops?
• Match revenue amounts to bank deposits. Does the money actually exist in the account?
• Cross-check sales records or invoices—were all earned revenues recorded?

✅ Example: If revenue is reported as $100,000, but only $80,000 has hit the bank, there could be missing payments or delayed deposits.

• Review Expense Categories
• Are expenses categorized correctly? A marketing expense shouldn’t show up under rent.
• Compare major expenses (rent, payroll, supplies) to prior periods—any sudden spikes?
• Look for expenses that seem out of place. A "miscellaneous" expense for $5,000 deserves a closer look.

✅ Example: If office supplies suddenly cost three times as much as last month, is it an error, an over-purchase, or an employee slipping in personal expenses?

• Analyze Net Profit (or Loss)
• Does the profit make sense based on revenue and expenses?
• If the business made a profit, is there actual cash in the bank to reflect that? (Hint: cash flow issues can make a business look profitable on paper but broke in reality.)

🚩 Red Flag Warning: If revenue is growing but profits are shrinking, costs may be rising faster than sales.

Balance Sheet – Does Everything Add Up?

The balance sheet is a financial snapshot showing what the business owns (assets), what it owes (liabilities), and what’s left over (equity). The formula must always balance:

ASSETS = LIABILITIES + EQUITY

How to Review the Balance Sheet

• Verify Bank Balances
• Compare bank balances on the balance sheet to the most recent bank statement. Do they match?
• If they don’t match, check for outstanding deposits or uncleared checks that haven’t hit the bank yet.

✅ Example: If the balance sheet says there’s $50,000 in the business account, but the bank statement shows $45,000, where did the missing $5,000 go?

• Check Accounts Receivable (AR) – Money Owed to the Business
• Look at the AR aging report—are there overdue invoices that haven't been paid?
• Are customers consistently paying late? This could indicate cash flow problems.

✅ Example: If customers owe $30,000 but half of it is over 90 days overdue, it's time to improve collections.

• Review Accounts Payable (AP) – Money the Business Owes
• Are all bills and invoices recorded?
• Are payments being made on time, or is there a risk of late fees or damaged vendor relationships?

✅ Example: If the balance sheet says there are $20,000 in unpaid bills, but the bank account has only $10,000 left, there’s a liquidity issue.

• Confirm Loan Balances
• Are all loans and credit card debts recorded accurately?
• Is the business making required payments on time?

🚩 Red Flag Warning: If liabilities (debts) are growing faster than assets, the business may be overleveraged and struggling with debt.

Cash Flow Statement – Where’s the Money Actually Going?

The cash flow statement shows how cash moves in and out of the business. It’s possible to have strong sales and even show a profit, but still run out of cash.

How to Review the Cash Flow Statement

• Compare Net Income to Cash Flow
• If the P&L statement shows a profit, but cash flow is negative, why?
• Look at operating cash flow—are customers taking too long to pay?

✅ Example: If net income is $20,000, but cash flow is negative $5,000, expenses may be eating up cash faster than revenue is coming in.

• Check for Large Outflows of Cash
• Were there any big, unexpected expenses?
• Did the business make a large inventory purchase or pay off a loan early?
• Analyze How Debt & Loan Payments Affect Cash
• If loan payments are draining cash, is there a way to refinance or restructure payments?

🚩 Red Flag Warning: If accounts receivable keeps growing but cash doesn’t, customers aren’t paying fast enough, creating a potential cash crunch.

Cross-Checking for Accuracy

Once financial statements are reviewed, the next step is to cross-check them against each other to ensure consistency:

• Does net income on the P&L match the increase in retained earnings on the balance sheet?
• Do cash transactions from the P&L align with cash movements in the cash flow statement?
• Are liabilities on the balance sheet reflected in expenses on the P&L or assets on the balance sheet?
• Does total revenue match bank deposit activity?

🚩 Red Flag Warning: If numbers don’t line up across financial statements, there may be errors, missing transactions, or even potential fraud.

Common Errors to Watch For (And How to Fix Them)

• Duplicate or missing transactions – Review bank reconciliations to catch duplicates.
• Incorrect revenue recognition – Match deposits to recorded sales.
• Mismatched bank balances – Double-check all transactions are entered.
• Payroll discrepancies – Compare payroll records to financial statements.
• Expense misclassifications – Ensure expenses are properly categorized.

A strong financial review doesn’t just find errors—it ensures financial reports are reliable, accurate, and useful for decision-making.

Step 4: Assess Internal Controls and Financial Processes

Accurate financial statements are essential, but strong internal controls ensure those numbers stay accurate. Internal controls are the policies, procedures, and safeguards that protect a business from errors, fraud, and financial mismanagement. Without them, a business is operating on trust alone—and trust is not a financial control.

This step focuses on identifying weaknesses in financial processes and implementing safeguards to prevent issues before they arise.

Key Areas to Assess in Internal Controls

① Segregation of Duties (Who is overseeing the money?)

Having one person control all financial tasks is risky. Dividing responsibilities ensures checks and balances.

✅ What to Check:

• Does the same person approve purchases, issue payments, and reconcile bank accounts? This can lead to a ripe opportunity for fraud.
• Are payroll and vendor payments reviewed by a second person? This helps create a system of checks to reduce fraud and mistakes.
• Is cash handling separate from recording transactions? Cash should always be handled by more than one person because it is incredibly easy for it to go 'missing'.

🚨 Red Flag: If one person has full control over financial transactions without oversight, there’s a high risk of fraud or mistakes going unnoticed.

② Approval and Authorization Processes (Who is signing off on financial transactions?)

A well-run business requires clear policies on approvals to prevent unauthorized spending.

✅ What to Check:

• Are purchase approvals documented and followed? Develop a process for purchases to be approved and ensure that all members of the organization are following it (yes, even executives and owners).
• Are large transactions reviewed by a manager or business owner? A robust approval process can allow for small purchases to have different approval requirements than large purchases.
• Are new vendors verified before payments are made? Requiring vendor approval prior to purchases can prevent fraud and ensure that company funds are spent with the appropriate vendors.

🚨 Red Flag: If employees or managers can make purchases without approval, expenses can spiral out of control.

③ Access Controls and System Security (Who has access to financial data?)

Financial data should be protected from unauthorized access and tampering.

✅ What to Check:

• Who has access to accounting software and bank accounts? Ensure that only the appropriate team members have access to your sensitive data.
• Are logins shared, or does each user have their own credentials? Set up individual credentials for each team member. This will allow specific user permissions to be established to allow only the appropriate access to the user. It will also help create an accurate audit log of who's doing what in the systems.
• Are former employees removed from financial systems immediately after departure? Add this step to your offboarding process for all employees and team members. Access should be removed immediately to avoid retaliatory actions.

🚨 Red Flag: If multiple employees share one login for accounting software, there’s no way to track who made changes.

④ Bank and Credit Card Reconciliations (Are transactions being verified regularly?)

Bank reconciliations help catch errors, missing deposits, and fraudulent charges before they become major problems.

✅ What to Check:

• Are bank statements reviewed and reconciled monthly? It's important to reconcile all accounts on a monthly basis to catch errors and issues promptly.
• Are reconciliations reviewed by someone other than the person handling payments? Separation of duties is key to catching fraud, but also identifying honest mistakes, as well.
• Are unexplained transactions investigated immediately? If reconciliations reveal any strange transactions, its important to investigate right away to identify and handle the problem before it snowballs on you.

🚨 Red Flag: If bank reconciliations aren’t done regularly, missing funds or errors can go undetected for months, sometimes until it's too late!

⑤ Expense and Reimbursement Controls (Is expense fraud slipping through?)

Without clear guidelines on business expenses, employees may abuse reimbursement policies or submit questionable charges.

✅ What to Check:

• Are expense reports reviewed for accuracy and policy compliance? Policy violations must be kicked out immediately, send a clear message about what is acceptable and what is not.
• Are receipts required for reimbursements? A good policy is to require receipts for ALL reimbursements. An occassional "lost receipt" might fly, but if employees are making a habit of it, you may have to take a stand in order to maintain compliance.
• Is there a spending limit before approval is required? Set a limit for your business that makes sense and require approval before the money is spent. In the end, this will provide a great deal of clarity for team members, but also streamline your reimbursement process.

🚨 Red Flag: If employees can approve their own reimbursements, there’s a high risk of fraudulent expense claims.

⑥ Fraud Detection and Prevention (Is there a system to catch financial misconduct?)

Even businesses with trusted employees should have fraud prevention measures. After all, trust is a key component of fraud.

✅ What to Check:

• Are vendor and payroll records reviewed for fake suppliers or ghost employees? Double check your payroll records and make sure that all of these people actually work for you. Don't forget about contractors!
• Are background checks done for employees handling finances? Background checks can reveal criminal and financial situations that can make employees more likely to commit fraud. Keep these folks away from your finances!
• Are anonymous fraud reporting channels available for whistleblowers? Create an anonymous communication channel for people to report what they see. This can help catch fraud before it goes on for too long.

🚨 Red Flag: If fraud controls are weak, dishonest behavior can go unnoticed until serious financial damage is done.

How to Strengthen Internal Controls

If weaknesses are identified, taking action quickly is key. Here’s how to improve internal controls:

✔ Implement Dual Authorization – Require two approvals for large transactions, vendor payments, and payroll changes.
✔ Use Accounting Software with Audit Trails – Track who made changes in financial records.
✔ Conduct Surprise Audits – Randomly check financial records to deter fraud.
✔ Limit System Access – Restrict financial data access to only necessary personnel.
✔ Train Employees on Financial Policies – Ensure all team members understand compliance and fraud risks.

Step 5: Examine Payroll and Expense Management

Payroll and expense management are two areas where errors, inefficiencies, and even fraud can easily slip through unnoticed. Mistakes in payroll can lead to compliance issues, tax penalties, and unhappy employees, while loose expense policies can drain cash flow faster than expected.

This step ensures that payroll is accurate, compliant, and secure, and that business expenses are properly tracked and controlled to prevent unnecessary spending or fraud.

Payroll Accuracy and Compliance

Payroll errors don’t just affect employees—they can trigger tax penalties, legal issues, and financial reporting problems. A proper payroll audit ensures that employees are paid correctly, taxes are filed properly, and payroll expenses match actual hours worked.

✅ What to Check:

• Are employee wages and salaries correct?
• Are tax withholdings (federal, state, local) accurate?
• Are benefits and deductions properly calculated?
• Do payroll records match reported expenses in the P&L statement?

🚨 Red Flag: If payroll tax filings don’t match actual payroll records, there could be underpayment, overpayment, or compliance issues.

How to Audit Payroll for Accuracy:

1. Reconcile Payroll Records with Bank Transactions – Ensure payroll payments match withdrawals in the business account.
2. Verify Employee Classifications – Confirm that all workers are correctly classified as employees or independent contractors.
3. Check for Ghost Employees – Review payroll for any employees who don’t actually work there (a common payroll fraud tactic).
4. Confirm Overtime and Bonuses – Make sure any overtime pay or bonuses were properly approved and recorded.
5. Review Payroll Tax Payments – Ensure all tax withholdings have been submitted on time to avoid IRS penalties.

✅ Best Practice: Use payroll software with automated tax calculations and compliance tracking to reduce human error.

Employee Expense Reimbursement Policies

Expense reimbursements can be a hotspot for financial leaks if not properly managed. Employees might submit personal expenses as business costs, round up mileage claims, or forget to attach receipts—all of which can cost a business thousands of dollars over time.

✅ What to Check:

• Are all reimbursed expenses properly documented with receipts?
• Do expense reports follow company policy (e.g., spending limits, approved categories)?
• Are personal expenses disguised as business expenses?
• Are expense reimbursements being processed correctly and fairly?

🚨 Red Flag: If employees approve their own reimbursements, there’s a high risk of expense fraud.

How to Audit Employee Expense Reimbursements:

1. Match Receipts to Transactions – Ensure that all expenses have a valid receipt and match what was claimed.
2. Check for Duplicate Reimbursements – Look for employees submitting the same expense multiple times.
3. Review Spending Trends – Are certain employees consistently overspending in particular categories?
4. Verify Mileage Claims – If employees claim mileage, compare reported distances with actual travel logs or GPS records.
5. Ensure Approval Process Is Followed – Expense reports should be reviewed and approved by a manager before reimbursement.

✅ Best Practice: Implement expense tracking software to automate approvals and detect policy violations.

Vendor and Supplier Payments

Vendor payments should be accurate, timely, and fraud-free. Without proper oversight, a business could end up overpaying vendors, paying fake invoices, or missing out on early payment discounts.

✅ What to Check:

• Are vendor payments matching purchase orders and invoices?
• Are any vendors being paid twice for the same service?
• Are there ghost vendors (fraudulent vendors set up to steal money)?
• Are vendor contracts and agreements being followed correctly?

🚨 Red Flag: If a single employee has full control over vendor payments, there’s a higher risk of fraudulent or unauthorized payments.

How to Audit Vendor Payments for Accuracy:

1. Cross-check Invoices with Purchase Orders – Ensure every invoice matches a legitimate purchase order.
2. Review Vendor List for Suspicious Entries – Look for duplicate or fake vendor names.
3. Check for Overpayments – If a vendor is being paid more than the agreed amount, investigate why.
4. Look for Unusual Payment Timing – If payments are made outside of normal billing cycles, it could signal fraudulent activity.
5. Compare Vendor Prices – Are long-time vendors still offering competitive pricing, or is it time to renegotiate?

✅ Best Practice: Require dual approval for vendor payments to prevent unauthorized transactions.

How to Strengthen Payroll and Expense Management

If payroll errors, reimbursement issues, or vendor payment inconsistencies are found, taking action quickly is essential. Here’s how to tighten controls:

✔ Implement Automated Payroll Software – Reduces human error and ensures compliance.
✔ Require Two-Level Approval for Large Expenses – Prevents unauthorized spending.
✔ Use Virtual or Prepaid Expense Cards – Allows tracking of every transaction in real time.
✔ Set Clear Policies on Employee Reimbursements – Avoids confusion and reduces expense fraud.
✔ Conduct Random Expense Audits – Helps detect fraud and policy violations before they escalate.

Step 6: Verify Tax Compliance and Regulatory Adherence

Taxes and compliance may not be the most exciting part of running a business, but ignoring them can lead to costly fines, penalties, and audits. This step ensures that tax obligations are met, filings are accurate, and the business is following all relevant financial regulations.

Review Business Tax Filings

Business taxes must be filed accurately and on time. Even small errors can lead to penalties or missed deductions.

✅ What to Check:

• Have all required tax filings been submitted for the year?
• Do tax payments match the amounts reported in financial records?
• Are there any outstanding tax liabilities or past-due notices?
• Are deductions and credits properly documented?

🚨 Red Flag: If tax records show inconsistent income or missing payments, the business may be at risk of a tax audit.

How to Audit Business Tax Filings:

1. Match Tax Filings with Financial Statements – Ensure reported revenue, expenses, and deductions align with the business’s P&L statement.
2. Check for Unused Tax Credits – Research whether the business qualifies for any tax credits or deductions that weren’t claimed.
3. Review Past Filings for Errors – If mistakes were made in prior tax returns, they may need to be amended.
4. Verify Estimated Tax Payments – Ensure that quarterly tax payments match IRS requirements.

✅ Best Practice: Work with a tax professional to identify potential savings and ensure tax compliance.

Sales Tax Compliance

For businesses that sell products or taxable services, sales tax compliance is a critical area of review. States and local governments aggressively enforce sales tax collection, so businesses must ensure they are charging, collecting, and remitting the correct amounts.

✅ What to Check:

• Are the correct sales tax rates being applied to customer transactions?
• Are sales tax collections properly recorded and separated from revenue?
• Are sales tax payments being submitted to the correct tax authorities?
• Are exemptions properly documented for tax-exempt customers?

🚨 Red Flag: If sales tax hasn’t been collected or remitted correctly, the business could face hefty fines.

How to Audit Sales Tax Compliance:

1. Compare Sales Tax Collected to Tax Liabilities – Ensure the correct amounts are being remitted.
2. Verify Tax Jurisdictions – Check whether the business is required to collect tax in multiple states (nexus rules).
3. Confirm Exemptions Are Documented – If customers are tax-exempt, ensure exemption certificates are on file.
4. Reconcile Sales Tax Reports with Financial Records – Any discrepancies between collected tax and reported tax should be investigated.

✅ Best Practice: Use automated sales tax software to track rates and filing requirements across different states.

Payroll Tax Compliance

Payroll taxes must be calculated, withheld, and submitted accurately to avoid IRS penalties. Employers are responsible for withholding employee income taxes, Social Security, Medicare, and any applicable state or local taxes.

✅ What to Check:

• Are payroll tax withholdings correct for all employees?
• Are payroll tax deposits being made on time?
• Do payroll tax filings match payroll expense reports?
• Are 1099s and W-2s issued correctly?

🚨 Red Flag: If payroll tax deposits are late or incorrect, the IRS can impose severe penalties, including interest on unpaid taxes.

How to Audit Payroll Tax Compliance:

1. Compare Payroll Records to Tax Filings – Ensure wages and withholdings match reports filed with the IRS.
2. Verify Employee vs. Independent Contractor Classifications – Misclassifying employees as contractors can lead to penalties.
3. Confirm Payroll Tax Deposit Due Dates – Ensure all required payments have been made on time.
4. Check for Unpaid Payroll Tax Liabilities – Review tax notices or outstanding balances with tax agencies.

✅ Best Practice: Use payroll software that automates tax calculations and ensures compliance with federal and state regulations.

Industry-Specific Compliance Checks

Some industries have additional regulatory and financial compliance requirements. Businesses should verify that they meet any industry-specific tax or legal obligations.

✅ What to Check:

• Are all business licenses and permits up to date?
• Are industry-specific taxes (e.g., liquor tax, environmental fees) being properly reported?
• Are financial regulations being followed (especially for businesses in healthcare, finance, or legal industries)?

🚨 Red Flag: If required permits, registrations, or licenses have expired, the business may be at risk of fines or shutdowns.

How to Audit Industry-Specific Compliance:

1. Review License & Permit Renewal Dates – Ensure all necessary business licenses are current.
2. Check for Industry-Specific Tax Obligations – Confirm whether the business is required to collect and remit special taxes.
3. Verify Compliance with Financial Regulations – Ensure any required financial disclosures or reporting obligations are being met.

✅ Best Practice: Keep a compliance calendar to track renewal dates and filing deadlines.

How to Strengthen Tax and Regulatory Compliance

If any tax or regulatory issues are uncovered, corrective action should be taken immediately.

✔ Automate Tax Filings – Use tax software to ensure accurate reporting and timely payments.
✔ Set Up a Compliance Calendar – Track tax deadlines, license renewals, and regulatory filings.
✔ Perform Regular Tax Audits – Conduct quarterly or annual tax reviews to prevent compliance issues.
✔ Work with a CPA or Tax Professional – Professional guidance can help businesses avoid costly mistakes.

Step 7: Identify Fraud Risks and Anomalies

Even the most well-run businesses are vulnerable to fraud, financial misconduct, and accounting irregularities. Whether intentional or accidental, these issues can lead to significant financial losses, compliance violations, and reputational damage.

This step focuses on spotting financial red flags, identifying potential fraud schemes, and strengthening controls to minimize risk.

Common Fraud Schemes in Small and Mid-Sized Businesses

Fraud isn’t always easy to detect, but understanding the most common schemes can help businesses recognize the warning signs.

Employee and Payroll Fraud

• Ghost employees – Fake employees added to payroll, with paychecks going to a fraudulent account.
• Falsified timekeeping – Employees inflating hours worked or claiming overtime they didn’t earn.
• Unauthorized bonuses or raises – Payroll adjustments without approval.

Expense Fraud

• Fictitious expenses – Employees submitting fake receipts for reimbursement.
• Personal expenses disguised as business costs – Employees claiming non-business expenses as work-related.
• Duplicate reimbursements – The same expense submitted multiple times under different categories.

Vendor and Accounts Payable Fraud

• Fake vendors – Fraudulent companies set up to receive unauthorized payments.
• Kickbacks – Employees colluding with vendors to inflate invoices in exchange for personal benefits.
• Duplicate payments – Paying the same invoice more than once, either by mistake or intentionally.

Revenue and Accounts Receivable Fraud

• Lapping schemes – Employees using funds from one customer to cover a missing payment from another.
• Skimming cash – Taking payments from customers before they are recorded in the books.
• Falsified revenue reporting – Recording revenue before it’s actually earned to manipulate financial results.

🚨 Red Flag: A single employee controlling both cash handling and record-keeping significantly increases fraud risk.

Red Flags to Watch For in Financial Records

• Unusual Transactions – Large, round-number transactions, repeated small payments, or payments made at odd hours.
• Unexplained Vendor Payments – New or infrequent vendors with no clear business purpose.
• Inconsistent Payroll Records – Employees receiving payroll but not appearing in HR records.
• Frequent Accounting Adjustments – Unexplained write-offs, voided transactions, or excessive journal entries.
• Employee Lifestyle Changes – An employee suddenly living well beyond their means may be diverting business funds.

🚨 Red Flag: If an employee is overly defensive or resistant to financial oversight, they may have something to hide.

How to Audit for Fraud and Anomalies

1. Review Bank and Credit Card Statements – Look for unusual withdrawals, unknown payments, or recurring charges that don’t match business expenses.
2. Analyze Financial Trends Over Time – Compare expenses, revenue, and payroll across different periods to detect inconsistencies.
3. Perform Random Spot Checks – Conduct surprise audits of petty cash, inventory, and expense reports.
4. Verify Vendor Legitimacy – Cross-check vendor records to ensure they are real businesses and not shell companies.
5. Match Revenue to Bank Deposits – Ensure all reported revenue corresponds to actual cash deposits.
6. Check for Duplicate Payments – Review AP reports to confirm vendors are not being paid twice for the same invoice.
7. Reconcile Employee Expense Reports – Compare submitted expenses to company policies and previous reimbursement patterns.

🚨 Red Flag: Employees who insist on handling all financial transactions alone may be covering up fraud.

Strengthening Fraud Prevention Controls

If fraud risks or irregularities are identified, the next step is tightening financial controls to prevent future issues.

✔ Enforce Segregation of Duties – No single person should control approvals, payments, and reconciliations.
✔ Require Dual Approval for Large Transactions – Payments above a certain threshold should require a second set of eyes.
✔ Use Expense Tracking Software – Automated software can flag unusual spending patterns.
✔ Implement Vendor Verification Processes – All new vendors should be reviewed and approved before payments are made.
✔ Encourage Anonymous Fraud Reporting – A whistleblower policy allows employees to report suspicious activity without fear of retaliation.
✔ Conduct Regular Internal Audits – Ongoing audits keep financial oversight strong and discourage misconduct.

🚨 Red Flag: A business that never audits its finances is at higher risk of fraud going undetected for years.

Step 8: Document Findings and Create an Action Plan

An internal audit isn’t just about finding issues—it’s about fixing them and improving financial processes for the future. This step ensures that audit findings are documented, prioritized, and addressed with a clear action plan.

Document Audit Findings

The first step is to record all observations from the audit. This should include:

• Errors and discrepancies – Incorrect financial entries, missing transactions, duplicate payments, etc.
• Compliance issues – Late tax filings, incorrect payroll deductions, sales tax miscalculations.
• Weaknesses in internal controls – Lack of approval processes, too much access for one employee.
• Potential fraud risks – Unusual transactions, ghost employees, or suspicious vendor payments.
• Operational inefficiencies – Bottlenecks in expense approvals, manual processes slowing down reporting.

🚨 Red Flag: If the same issues keep recurring in multiple audits, the underlying processes likely need an overhaul.

Prioritize Issues Based on Risk and Impact

Not all issues require the same level of urgency. Organizing findings into priority levels helps focus efforts on the most critical problems first.

🟥 Critical Issues (Immediate Action Required)

• Fraud indicators or high-risk financial discrepancies.
• Compliance violations that could result in fines or legal penalties.
• Unrecorded or missing transactions that affect financial accuracy.

🟧 Moderate Issues (Address in the Short Term)

• Process inefficiencies that slow down financial reporting.
• Expense or payroll inconsistencies that could lead to minor errors.
• Lack of segregation of duties, increasing the risk of internal fraud.

🟩 Low-Priority Issues (Long-Term Improvements)

• Outdated accounting software or manual processes that could be automated.
• Policy gaps that should be clarified but do not pose immediate risks.
• Training needs for employees handling financial tasks.

🚨 Red Flag: If critical issues remain unresolved from past audits, they could escalate into larger financial problems.

Develop an Action Plan

Each issue should have a clear resolution plan, including:

✔ The specific action required (e.g., correcting financial records, improving controls, implementing software).
✔ Who is responsible for fixing the issue (accounting team, HR, management, external accountant).
✔ A deadline for resolution (immediate, 30 days, next audit cycle).
✔ How progress will be monitored (follow-up reviews, updated policies, ongoing checks).

💪 Example Action Plan Entry:

🚨 Red Flag: If no one is assigned responsibilityforgotten or delayed.

Communicate Findings and Next Steps

Once the action plan is established, findings and recommendations should be shared with key stakeholders, including:

• Business Owners & Executives – To approve financial process improvements.
• Accounting & Finance Teams – To implement corrections and strengthen controls.
• Department Heads – If financial issues impact operational budgets or spending policies.

✅ Best Practice: Schedule a post-audit meeting to discuss findings, ensure alignment, and confirm corrective actions are being implemented.

Schedule Follow-Up Audits

An internal audit isn’t a one-time event—it’s an ongoing process. Regular follow-ups ensure that:

✔ Corrective actions were actually implemented.
✔ Past mistakes haven’t resurfaced in future audits.
✔ New financial risks are identified and addressed proactively.

Recommended Follow-Up Frequency:

• 30-60 Days After the Audit: Verify that immediate corrections have been made.
• Quarterly Audits: Spot-check critical financial areas (payroll, expenses, tax compliance).
• Annual Full Audit: A complete review of financial health and internal controls.

🚨 Red Flag: If audit follow-ups are skipped, financial issues may resurface unnoticed in future reporting.

Step 9: Implement Long-Term Financial Best Practices

An internal audit isn’t just about fixing immediate issues—it’s about strengthening financial management for the long haul. This final step ensures that audit findings translate into ongoing improvements, better financial oversight, and sustainable business growth.

Establish Routine Financial Reviews

Waiting for an annual audit to catch financial problems is too risky. Implementing routine financial check-ins keeps finances accurate, compliant, and fraud-free.

✅ Best Practices for Ongoing Financial Reviews:

• Weekly: Manage company spending, ensuring validity of expenses.
• Weekly: Review invoices, payments, and outstanding receivables.
• Monthly: Conduct a mini-audit of financial statements, expenses, and payroll.
• Quarterly: Assess tax compliance and evaluate financial trends.
• Annually: Perform a full-scale internal audit before tax season.

🚨 Red Flag: If financial reviews only happen when something “feels off,” small problems can snowball into major financial crises.

Automate and Streamline Financial Processes

Manual financial tracking is prone to errors and time-consuming. Investing in automation reduces mistakes and improves efficiency.

✅ Key Financial Processes to Automate:

• Bank reconciliations – Automated tools can flag mismatches in transactions.
• Expense tracking & approvals – Digital expense management prevents duplicate or fraudulent claims.
• Invoice processing & collections – Automated invoicing speeds up receivables.
• Payroll tax calculations & filings – Reduces compliance risks.
• Financial reporting – Real-time dashboards improve visibility into cash flow and profitability.

🚨 Red Flag: If financial processes still rely on manual data entry and spreadsheets, errors and inefficiencies are bound to occur.

Strengthen Internal Controls to Prevent Fraud & Errors

An internal audit often exposes gaps in internal controls that make a business vulnerable. Strengthening these controls reduces the risk of financial misconduct and operational mistakes.

✅ Essential Financial Controls:

• Segregate duties – No single person should control payments, approvals, and reconciliations.
• Enforce dual approvals – Large expenses and vendor payments should require two levels of sign-off.
• Limit financial access – Only authorized personnel should have access to sensitive financial data.
• Conduct surprise audits – Random checks help catch fraud before it escalates.
• Implement vendor verification – Review new vendors before issuing payments.

🚨 Red Flag: If a single person has complete control over financial transactions without oversight, fraud risk skyrockets.

Keep Tax & Compliance Records Organized

Messy or missing records lead to last-minute scrambling, missed deductions, and compliance risks. Organizing tax and regulatory documents ensures smooth filing and audit-proof financials.

✅ Best Practices for Tax & Compliance Organization:

• Store all tax filings, invoices, and payroll records in digital folders by year.
• Set reminders for tax deadlines and permit renewals to avoid penalties.
• Keep copies of all W-2s, 1099s, and tax exemption certificates for at least 5-7 years.
• Document policy changes in financial processes for future reference.

🚨 Red Flag: If financial documents are scattered across multiple locations (emails, desk drawers, shoeboxes), compliance risks increase.

Train Employees on Financial Policies

A financial system is only as strong as the people using it. Employees handling financial tasks need proper training on policies, fraud prevention, and compliance requirements.

✅ Key Training Topics:

• Expense reporting guidelines – What’s reimbursable and what’s not?
• Payroll compliance – How taxes and deductions are calculated.
• Fraud awareness – Recognizing red flags in transactions.
• Financial software training – Ensuring proper use of automation tools.

🚨 Red Flag: If employees aren’t trained on financial policies, errors and compliance risks become inevitable.

Develop a Financial Contingency Plan

Unexpected financial challenges will happen—whether it’s a cash flow crunch, an IRS audit, or an economic downturn. Having a contingency plan ensures the business can navigate financial difficulties smoothly.

✅ What a Strong Contingency Plan Includes:

• A cash reserve goal for emergency expenses.
• A plan for reducing expenses quickly if revenue drops.
• Alternative funding options (lines of credit, emergency financing).
• A checklist for handling IRS audits or compliance reviews.

🚨 Red Flag: If a business has no financial safety net, unexpected disruptions can jeopardize operations.

Conduct Future Internal Audits Regularly

An internal audit isn’t one and done. It’s an ongoing financial health check-up. Setting a schedule for future audits ensures continuous improvement and financial stability.

📅 Recommended Internal Audit Schedule:

• Quarterly – Mini-audits on cash flow, payroll, and tax compliance.
• Annually – Full-scale financial audit to evaluate internal controls and accuracy.
• After major business changes – If revenue, staffing, or regulations shift, a targeted audit may be necessary.

🚨 Red Flag: If an audit only happens when financial problems arise, the business isn’t proactively managing its finances.

Remember that feeling when we first mentioned “internal audit”—the slight panic, the mental image of endless spreadsheets, and maybe a tiny urge to run in the opposite direction? Well, now that we’ve walked through the process step by step, it’s clear that an internal audit isn’t a punishment—it’s a power move.

Rather than waiting for a financial crisis, tax notice, or a fraud discovery that leaves everyone scrambling, an internal audit puts business owners in the driver’s seat. Done right, it ensures:

✔ Financial accuracy – No more surprise errors or unbalanced books.
✔ Fraud prevention – Stopping small leaks before they sink the ship.
✔ Compliance confidence – Keeping tax authorities and regulators happy.
✔ Better decision-making – Using real, reliable numbers to guide growth.

At the end of the day, an internal audit is like a financial wellness check-up for a business—uncomfortable at first, but absolutely essential for long-term health. The best part? It’s not a one-time event; it’s a habit. And just like regular exercise keeps the body in shape, regular financial check-ins keep a business strong and prepared for anything.

💡 Final Thought: Businesses that stay proactive, rather than reactive, are the ones that thrive. So set that next audit date, tighten those internal controls, and make sure your finances are working for you—not against you.

And if all of this still feels overwhelming? We’re here to help. Whether it’s reviewing financial statements, strengthening internal controls, or simply making sense of the numbers, a trusted financial partner can turn insights into action.

🚀 Ready to get your finances audit-proof? Let’s talk!

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as financial advice. Consult with a qualified professional for personalized guidance tailored to your specific needs and situation. Feel free to reach out to The Numbers Agency for a free consultation to see what how we can help!