Internal Auditing: Key to Helping Your Operations and Bottom Line

By Thomas J. Menk, CPA, Shareholder and Director of Comprehensive Risk Services, Alpern Rosenthal

Over the past several years, we have seen headlines related to major corporate scandals and investor losses. In the wake of these scandals, there has been a renewed focus on the role of the internal auditor in the prevention and detection of accounting errors, control weaknesses and fraud.

While this renewed focus should increase the reliability of the financial reporting process, it overshadows some of the most significant benefits of an effective internal audit function—more cost-effective business processes that lead to increased stakeholder returns.

Common misconceptions
While many people consider an internal audit to be a tool to monitor compliance with company policies and procedures, the actual focus of an effective internal audit function is much broader in scope. In fact, the Institute of Internal Auditors defines internal audit as “an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.” The traditional perception of internal audit was that of a corporate watchdog. However, over the past decade the role of the internal auditor has evolved gradually into a more consultative role with a strong focus on risk management and business performance improvement.

What is so special about internal audit?
Take a look at any organizational chart and you will find multiple functional domains, with very few parties who have interaction with all of these domains. These organizational silos almost always increase the risk of a failure to identify or communicate significant internal or external factors that might impact a company’s operations. Because of the nature of the internal audit function, it might be one of the few roles that bridges across each critical domain to get an unobstructed view of risks impacting the business. Based on the internal auditor’s understanding of all of these organizational objectives and risks, combined with their experience in the analysis and implementation of effective internal controls, internal auditors are uniquely qualified to help implement cost-effective processes that are clearly aligned with management’s objectives. The resulting internal controls minimize administrative costs and contribute to higher operating margins.

Objectives and risks
The ultimate goal of an effective internal audit function is to facilitate achieving organizational objectives in a wide range of areas, including operations, financial reporting and regulatory compliance. Accordingly, the fundamental starting point is the clear definition of organizational objectives. Once these objectives are defined, management can more effectively identify risks to achieving these objectives, which serve as the foundation for constructing cost-effective internal controls.

Management’s objectives—whether formally defined or not—typically cover a broad spectrum of areas, including but not limited to: identifying market trends and competitors, maximizing manufacturing efficiencies, and minimizing credit exposure. As the list of critical objectives grows, so does the number of risks impacting the achievement of those objectives.

Due to their wide range of operational, financial reporting and regulatory compliance skills, internal auditors are uniquely qualified to facilitate the process of risk assessment and management. In addition to their business-specific knowledge, internal auditors also bring to the table proven risk assessment tools and techniques that include comprehensive databases of typical business objectives and related risks as well as off-the-shelf and customized software products to facilitate the assessment. These tools enable management to conduct a much more targeted, cost-effective assessment of objectives and risks.

The internal auditor’s typical approach involves the analysis of existing procedures through interviews with key managers, analysis of processes and information technology systems used in day-to-day operations and comparison to industry “best practices.” In many cases, this analysis is facilitated by the use of standard internal audit tools that include matrices of common organization objectives, risk events that threaten the achievement of the objectives and typical controls to mitigate these risk events. These tools allow management to identify issues in a much more cost-effective manner.

The Benefits of Internal Audit
While internal audit has long been commonplace at most of the largest U.S. companies, many mid-sized companies are beginning to realize the benefits of an internal audit function. And in today’s environment, establishing an internal audit function does not necessarily mean investing hundreds of thousands of dollars. Many options are available that can be tailored to the size and complexity of the business, and some eliminate the fixed burden of a full-time internal audit function. These options often include some form of internal audit outsourcing or co-sourcing, where third party internal audit experts provide either all or part of the internal audit resources on a part-time basis.

Some of the benefits of these fully or partially outsourced arrangements include:

1. Independent evaluation. A second look by an experienced, third-party practitioner can provide new and innovative ideas for improvement.

2. Experience. In many cases, third-party personnel have provided accounting and consulting services for a number of years and have reviewed, tested and evaluated internal controls and operating systems for multiple organizations in numerous industries.

3. Industry expertise. Third-party internal audit experts can provide specialists in virtually any industry.

4. Flexibility. As your business evolves, your internal audit needs also evolve. By tapping the resources of an outsourced internal audit practitioner, you can gain access to experts who can help you address challenges resulting from changes in your business.

5. Affordable cost. By using third-party experts, you can minimize the fixed cost associated with in-house internal audit functions.

The Institute of Internal Auditors estimates that, in general, internal audit fees should approximate 0.3 percent of annual revenues. Given the potential benefit of expanded insight into business objectives, risks and processes, this investment would appear more than worthwhile for any sized company.

Through the effective implementation of an in-house or outsourced internal audit function, companies can define critical organizational objectives and ensure that control activities and processes are in line with these objectives, resulting in substantial operating efficiencies and increased operating margins.

Thomas J. Menk, CPA, is a Shareholder and Director of Comprehensive Risk Services for Alpern Rosenthal. He can be reached at 412.281.1566 or at tmenk@alpern.com.

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