Value based internal audit, LD Mahat

Background

Management of every business organisation is facing the challenge of enhancing their performance. Value based measures are gaining popularity in measuring the performance these days. An alternative approach to managing an organisation has been developed in recent years as value-based management. This approach of management assumes that maximizing the value of a company to its shareholders also maximizes the value of the company to the society at large. The concept of shareholders value as an objective appears to be widely accepted within the accounting community. However, its use as a quantified evaluation is less often found in practice.

Value Based Audit

Like value-based management, another innovative way for enhancing the value of a company is the development of value based internal audit system. The winds of change are pushing their way into every area of business operation, creating new expectations and opportunities. Like other support area, internal audit, faces challenge to deliver real value and contribute to overall corporate strategy. Like any other functions of the business internal audit also must be able to demonstrate results and deliver the value to the company. Value based internal audit system is aimed at generating value for the company rather than fine-tuning the organisational process. In order to deliver value, the internal audit resources and skills must be aligned with the expectations of the management and the business strategy.

Balanced Scorecard: an Indicator of Value Addition

In developing a value-based internal audit program, balanced scorecard is a tool used to find out the value added by the internal audit operations. The financial measures of a company evaluate the performance of a company based on the information computed from financial statements. Although financial measures are informative, one of its major drawbacks is that it talks only about the historical data. On the other hand, non-financial operational measures tell the story about the drivers of future financial performance. Therefore, the balanced scorecard measures the performance of a company from different perspectives, viz., financial, customer, internal business and internal learning activities.

Financial perspective

Financial perspective of a balanced scorecard is concerned with the evaluation of the company in the market based on its financial indicators. For example, one can measure profitability of a company as return on equity, return on investment, return on capital employed, price/earnings ratio, gross profit margin, net profit margin, etc. Similarly, debt equity ratio and various coverage ratios measure leverage. likewise, current and quick ratios measure liquidity. Financial indicators of a company can be interpreted as indicators of its prosperity.

Customer perspective

Customer perspective of a balanced scorecard focuses on who delivers revenue to the company. It is the customer, not the products or services, who is important contributor in the revenue of a company. Customers will have concern on the following:

  • On-time delivery of the products or services;
  • complaints of the customers regarding quality of the products or services; and
  • comment cards filled by the customers regarding the performance/service of the company

Internal business perspective

The internal business perspective of a balanced scorecard addresses the issues relating to the processes used by the company to achieve customer satisfaction. For example, a defect rate of a product measures its quality. Similarly, environment sensitivity of a company is measured by its waste recovery system. Likewise, production efficiency is measured by the capacity utilization. Product development is measured by the fact as to whether the product was introduced first in the market.

Internal learning perspective

The internal learning perspective of a balanced scorecard addresses the issues relating to the improvement in the business processes. Continued learning repositions of a company’s comparative advantage in the market place for ideas, offering opportunities to launch new products, improve operating efficiencies, penetrate new market and create more value to the customers.

The balance scorecard approach uses various performance indicators mentioned above as value drivers. This approach is not a one-time approach; it is a systematic and ongoing process aimed at aligning internal audit performance and corporate strategy. It offers a comprehensive assessment of progress made, translating the strategy into action. Balanced scorecard approach gives the management a fast but comprehensive view of the organizations performance and includes both process and result measures.

Transforming Internal Audit

Transforming the traditional internal audit into value based internal audit is not an easy task. For many internal auditors, assuming the role of change agent is a huge and unsettling leap. Change doesn’t come easily to any well-established business function and internal audit is not an exception. Traditionally, its role has focused on well-defined issues revolving around control and compliance. As a result, many internal audit groups have only limited experience in managing risk or offering business consulting advice on improving processes or best practices. Such a narrow focus is very difficult to change.

New technology, e-business, and the persistent drive to do more with less have all converged to bring internal audit to the forefront of corporate risk management and process redesign. As a result, more and more companies are challenging their internal audit departments to move beyond compliance and control and embrace a broader, more consultative agenda. So, the top priorities on that new value-based agenda are improving business processes, managing risk, and unlocking new sources of profitability.

Conclusion

There are a host of opportunities for internal audit to make solid contributions in enhancing the value of a company. Some of the high impact area could be maximizing the revenues by controlling and preventing revenue leakages; controlling costs; assessing the risks undertaken by the company; improvement in the business processes; and increasing the cross-functional efficiency and safeguarding information assets. A company must consider internal audit as a lever for competitive advantage rather than only a necessary evil.

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