Debate over value of SME audits rages

SME AUDIT ADVOCATES argue that exempting smaller companies from the reviews will deter banks from financing them, but stakeholders claim lenders’ interest in the documents is minimal.

The debate over the value of audit for SMEs has been stoked by business secretary Vince Cable’s calls to raise the threshold in a bid to relieve smaller outfits of the financial and administrative burden of statutory audit.

Currently, businesses with a turnover of no more than £6.5m or a balance sheet under £3.26m are exempt, and a new test means companies that satisfy these criteria and employ fewer than 50 staff are also excused.

Defenders of audit for SMEs warn that banks will refuse to finance companies without robust financial reporting, potentially dragging them into a cash crisis. But a number of mid-tier firms argue this is not the case, saying banks attach greater importance to robust internal reporting, and focus on management accounts or reviews from existing suppliers before turning to audits.

Jonathan Russell, partner at ReesRussell, suggested many banks do not understand audits anyway, and claimed the lengthy preparation process means the documents can be as many as 18 months out of date before they enter the public domain.

High-quality internal financial reporting is enough for most lenders, and the current audit threshold is “overkill” for smaller entities, Harris Lipman partner Russell Whitlock warned. He suggested the decision should be on a case-by-case basis, but said he would still push audit for finance-focused companies.

Peter Mitchell, chairman of the Society of Professional Accountants, has gone one step further. He argued in the few years since the last audit threshold boost that no SMEs freed from statutory audit have run into difficulties from stick-in-the-mud lenders dem­anding the review. On this basis, he claimed, there is no fear that raising the threshold audits will deter banks from financing SMEs.

But traditionalists dismiss as absurd the idea that companies can prove their credit-worthiness without carrying out an audit.

Academic Stella Fearnley said an audit is the only way to have confidence in business numbers, rubbishing the suggestion that internal reports can stand in their stead. She described the audit threshold as a “silly default position” arising from the over-complexity of today’s audit, which has made it easier for regulators to allow SMEs to drop off the bottom than require all companies to carry out a robust piece of assurance.

Fearnley conceded banks with a long-standing relationship with their clients might make less stringent demands when refinancing, but insisted an audit is a prerequisite for new would-be borrowers.

The British Bankers’ Association is not so sure. Assistant director Brian Capon said banks are “relaxed” about the prospect of a higher threshold, adding: “It won’t make much difference to the willingness to lend.” Financiers generally hold a wealth of information on companies – especially existing clients – upon which to base lending decisions, he said. Data drawn from working accounts is often enough to paint an accurate picture of the borrower, and an audit would only be required in cases where the requested loan was particularly high, or the decision “finely balanced”.

Mid-tier firms stand to lose out if their clients’ audit requirements evaporate, but the majority are eager to see the changes made. Banks and Co said lifting the threshold will mean “significant savings for small firms”, citing Cable’s figure of 42,000 businesses saving £40m per year.

The firms already have their eyes on the future, saying the time and money formerly expended on audit will be redeployed for valued-added services. They are confident, too, of retaining their clients and selling them alternative services.

These include advice on risk management, early warning mechanisms and strengthening internal reporting. They argued lenders are more concerned with these pillars of business in any case, and will be happier to fund companies using value-added services to strengthen their market position, even without an audit in hand.

Andrew Watkin, partner at Baker Watkin, insisted on the value of audit for SMEs, saying they can boost companies’ credit ratings and encourage banks to lend. However, he described the proposed audit threshold boost as “negligible”. The difference in internal controls between a company with £6m turnover and one of £8m is minimal, he argued, saying it would be more game-changing to lift the threshold above the £20m mark.

Other stakeholders agree, with some arguing for the limit to be set as high as £25m. The BBA said if such a change were made, the requirement for audit would still be decided on a case-by-case basis, suggesting the review holds less sway than some have suggested.

Nay-sayers warned lifting the threshold above £20m really would cause concern, claiming it significantly increases the risk of financial mismanagement and poor internal controls.

Despite their protestations, it seems likely that the threshold will continue to creep higher, as mid-tier firms, banks and Cable are all pushing for SME audits to be redefined as a non-essential asset.

(Picture © Duncan Philips/CASS/BIS)