external audit
Think of a referee in a sports match. The referee does not play for either team, is paid to be fair, and exists so that everyone can trust the final score. An external audit puts a referee on a company's financial statements: an independent accounting firm, hired from outside the company, examines the books and reports to the owners and the public on whether the statements are fairly stated. The key word is independent — the auditor must not be part of management and must have no stake in the answer.
In an external audit, the company's own employees prepare the financial statements; the external auditor then plans the work, assesses risks, tests internal controls, gathers evidence about the balances and transactions, and finally issues a formal audit opinion. The auditor is engaged by and reports to the shareholders or the board (specifically, an audit committee), not to the managers whose work is being checked — this reporting line is what protects independence. For public companies in many countries, an external audit is required by law every year, which is why it is also called a statutory audit.
External audits matter because they are the backbone of trust in capital markets: share prices, loans, and contracts all rest on numbers that strangers cannot verify themselves. The honest tension to understand is the so-called 'self-interest threat': the audit firm is usually paid by the very company it audits, and wants to keep the client. Rules on independence, rotation, and limits on consulting work exist precisely to keep that conflict in check — but it is a real and permanent feature of the model, not a solved problem.
A listed retailer's finance team closes the year's books and prepares its statements. An outside firm — not employees of the retailer — is then engaged by the audit committee to test those statements and report to shareholders whether they are fairly presented. The retailer pays the fee, but the firm answers to the board, not to the CFO.
The auditor is hired by the board to check management's work, not the other way around.
Independence is the whole point but is never absolute: the auditor is usually paid by the company it audits. Rotation rules and bans on certain side services exist to limit, not erase, that conflict.