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Why You Should Question the Auditor
by Lynn Grooms

Why is our operating expense $.30 per bushel while the industry average is $.25? Do we have adequate internal controls in place? Are we generating adequate earnings to service our debt? These are the kinds of questions that managers and board members should ask during the audit process or when reading financial reports. These are the kinds of questions that can help spark necessary changes to improve the company’s bottom line or turn around losses. These also are the kind of questions that were discussed recently in a session at the annual convention of the Grain & Feed Association of Illinois in which Brad Lee, vice president, agribusiness, CoBank, St. Louis, Mo., provided a lender’s perspective. CoBank provides a variety of financial solutions, and one of its specialties is agribusiness financing.
Are many of today’s grain elevator and feed mill boards sufficiently involved in the audit process? “It depends on how you define the audit process. If a company is performing well, board involvement may be a non issue, but if a company has lost money or has significant issues, the board will want to be more engaged--asking questions, requesting a business plan to address the issues, and helping to put the company back on the right track,” says Lee.
A company’s board may not be any more involved than interviewing and hiring the auditor and asking questions throughout the audit process, says Lee. “They may have questions up front or be interested in staying informed of the audit.” But what the board actually does with the information is the most important element.
Reasons for an Audit
It may be helpful to review the reasons for an audit, which Lee presented at the Illinois meeting:

1. Examine and verify the integrity of accounting records and internal control procedures.
2. Serve as a control instrument over the record keeping for which management and administrative personnel are responsible.
3. Examine, verify and report the financial condition (balance sheet), results of operations (operating statement) and statement of cash flows for a given time period.
4. Facilitate obtaining credit from banks, third party creditors or meet regulatory requirements.
5. Identify the need for financial consultation and guidance when appropriate.
6. Satisfy members and stockholders that their interests are being adequately safeguarded by the board and management.

Audits should be conducted annually at a minimum. But under certain circumstances, a company may want to have more than one audit per year. A small company with a minimum accounting staff, for example, may want to rely on an outside auditor to help with regular financial statements. Or, a company that has had past problems with financial statements may want to have an outside firm do a review every six months, says Lee.
Hiring an Auditor
Say that a company is looking to hire an outside audit firm. Should the auditor have specific experience in grain elevator and/or feed mill management? One of the benefits of hiring an auditor who has been involved with several similar operations is that he or she will likely have a better overall picture about how this type of business operates, says Lee. This auditor also will likely be better able to identify trends (in operating costs, margins or trading practices, for example). Or, a company may be more interested in convenience or lower cost and hire a local auditing firm, for example.
Before hiring an auditor, the board should determine several qualifications. The interview process, says Lee, should reveal:

• Professional competence
• Ability to maintain independence and a high degree of integrity
• Understanding of your particular business and industry
• Ability to conduct an efficient audit program
• Ability to communicate with the board and management
• Ability to provide competent suggestions for improving financial accounting practices
• Understanding of their reporting responsibility directly to the board
• Willingness to correct any oversights occurring during the audit program
• Does the audit firm have an active peer review process
• Trusted advisor status

Once an auditor is selected, the board should then ask some questions about the auditor’s engagement letter. This is the formal contract between the board and the audit firm, says Lee. These questions might include: What else will you bring to the table other than the audit? What specific services are you going to perform? What will this audit include? How will we be billed? Will the audit include tax preparation? What tax expertise does the audit firm have? If it does not have this expertise, what provision will it make to provide such expertise? How are you going to measure quantity and quality of inventory at year end?
“One of the audit firm’s responsibilities is to make sure management is within the policy guidelines established by the board,” says Lee. The more specific these guidelines are, the easier it is for the auditor to see if the company is in compliance with them. Take a company’s credit policy, for example. The terms of sale should be clearly indicated. If an invoice is not paid within 30 days, then a service charge should be added if that is their policy. The audit process will go more smoothly if policies are well documented.
Once the auditor is hired, how frequently should the board request progress reports? There really is no ideal number, although a larger company might request them more frequently. Management should inform the board when the auditor will be on site and the board also may want to be involved when inventory is being taken, says Lee. After that, a meeting of the auditor, board and management should be scheduled.
It is at this meeting where thought-provoking questions can really help the company’s short-term and long-term financial performance. As Lee pointed out in his presentation at the Grain & Feed Association of Illinois meeting, the following questions can yield some very good answers at the audit board meeting:

• What are the trends (for the following): sales, margins, expenses, earnings, assets, working capital, net fixed assets, long term debt and net worth?
• How do these compare to similar companies?
• Do we have adequate internal controls in place?
• Are we operating within the parameters of our risk management policy?
• Do we have adequate policies in place?
• Are there any concerns relative to the quantity or quality of our inventory?
• Based upon our current cash flow requirements, are we generating adequate earnings to service our debt and maintain our plant and equipment?
• Are accounts receivable current and do we have an adequate allowance?
• Are payables being met within terms?
• Have assets and liabilities been properly safeguarded?
• Do our internal financial statements accurately reflect the “true” position of our company on an ongoing basis?
• Are we following the policies established by the board (e.g., drying, storage, grain contracts, etc.)?
Further, Lee encourages companies to have four or five key financial ratios to measure performance. These could include working capital to sales, operating expense/bushel, return on invested capital, return on equity, EBITDA divided by interest, long-term debt to equity and more.
Finally, as in any business relationship, good communication is key. As Lee says, “If everyone knows what is expected up front and that everything is on the table, there can be a free exchange of information.”

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