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| Kathmandu, Wednesday February 26, 2003 Falgun 14, 2059. |
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Value based internal audit
By L D MAHAT
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 maximising the value of a company to its shareholders also
maximises 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 but
its use as a quantified evaluation is less often found in practice.
Like value-based management, another innovative
way for enhancing the value of a company is the development of value based the internal
audit system. The winds of change are pushing their way into every area of business
operation, creating new expectations and opportunities. Every support area, including
internal audit, is being challenged 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. The value-based internal
audit system is aimed at generating value for the company rather than fine-tuning the
organisational process. The audit programme tends to redefine its mission and priorities
and focuses on the value generating activities that support the real growth of the
company. Such a system demands a breadth of expertise of the internal auditor far beyond
traditional corporate compliance. To deliver value, the internal audit resources and
skills must be aligned with the expectations of the management and the business strategy.
In developing a value-based internal audit
programme, 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 of a balanced scorecard is
concerned with the evaluation of the company in the market based on its financial
indicators. For example, profitability of a company is measured by return on equity,
return on investment, return on capital employed, price/earnings ratio, gross profit
margin, net profit margin, etc. Similarly, leverage is measured by debt equity ratio and
various coverage ratios. Liquidity of a company is measured by current and quick ratios.
Financial indicators of a company can be interpreted as indicators of its prosperity.
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. 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 could be some of the measures from the perspective of the customer.
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.
Environment sensitivity of a company is measured by its waste recovery system. Production
efficiency is measured by the capacity utilisation. Product development is measured by the
fact as to whether the product was introduced first in the market.
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 organisations performance and includes both process and
result measures.
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. The top priorities on that new value-based
agenda are improving business processes, managing risk, and unlocking new sources of
profitability.
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 maximising the revenues by controlling and preventing revenue
leakages, controlling costs, assessing the risks undertaken by the company, improvement in
the business processes, increasing the cross-functional efficiency and safeguarding
information assets. Internal audit must be considered by the company as a lever for
competitive advantage rather than only a necessary evil.
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