Importance of Internal Audit for SMEs

Posted on 30, August 2020

Importance of Internal Audit for SMEs

To understand the importance of internal audit, it is important first to differentiate between internal audit and external audit.

Generally, there are two main types of audit i.e. external audit and Internal audit. For majority of people who are not from financial background, the word audit implies only external audit i.e. audit of year-end financial statements and they do not have the clear understanding of internal audit. The table below highlights key differences between internal and external audit.

External Audit Internal Audit

The scope of external audit is very limited as compared to internal audit. It involves mainly verifications as per International Standards on Auditing of financial statements i.e. Income statement, balance sheet, statement of changes in equity, statement of cash flows and notes to financial statements.

Internal audit scope is very broad and detailed and is generally defined in internal audit charter of the company. In addition to reviewing reliability and correctness of financial information, it also covers almost all areas/department of a business especially governance, risk management, operation, and compliance. Its scope also involves providing consulting services within the company.

External auditor is a registered auditor who is independent third party appointed by the shareholders of the company.

Can be outsourced to external third party or can be full-time employee or internal audit department of the company. 

Audit Report has a specific format as per auditing standards (normally two pages) on Financial Statements, and it is addressed to shareholders of the company and contain auditor opinion in standard format on financial statements whether financial statement give true and fair view or not. 

Detailed reports for each area under audit is issued and subsequent follow up are made. For instance, in finance and account department there can be several internal audit reports for each section such as Receivable, Payable, Payroll, Fixed Assets, Cash Management. Same applies to other departments of the company depending on the size of company.

Audit Report is mostly needed for shareholders and external stake holders such as banks investors, regulators etc.

Internal audit reports are for internal use of audit committee/board/senior management.

Conducted once in a year normally after the end of the financial year.

Internal audits can be conducted throughout the year as per Approved Annual Audit Plan.

Mostly external audit is a statutory requirement and ensure reliability of the financial statements of the company.

Add values to the businesses, ensure efficiency and effectiveness of operations, better monitoring as have more detailed understanding of business.

Hope the above table has contributed significantly to your understanding of internal audit and now we can proceed to discuss the importance of internal audit for small and mid-size enterprises (SMEs).   

Large organizations have a full-fledged internal audit department staffed adequately with the required resources who are performing and reporting throughout the year on internal audit engagements. Not all mid-size entities have a full-fledged internal audit department or may have one or two employees employed as internal auditor or no employees at all. As for the small business is concerned, it is very rare to have an internal auditor. Normally, the importance of internal audit in SMEs is not realized and this is often understood same as external audit.

However, it is very important for the SMEs to have internal audit function because of the following reasons:

1) SMEs especially small business do not have reasonable expertise and resultantly accounting and internal control system in placed are inadequate. This emphasizes the importance of internal audit for SMEs whether in house or outsourced.

2) Internal audit serves as major tool for detection and especially prevention of fraud in SMEs. This is well known fact that SMEs are many times more prone to frauds than large organization.

3) The role of internal audit in a company ensure the correctness and reliability of financial and operating information as mechanism of review and reporting exist.

4) Internal auditors are well experienced with the compliance matters and they can ensure compliance with relevant rules and regulations.

5) Internal audits identify areas for optimizing resources and saving costs.

For SMEs, outsourcing internal audit is a suitable option as compared to full-time in-house internal audit function because it is cost effective, flexible, offers better experience and expertise, independent and unbiased reporting and most importantly internal audit services can be directed for only high-risk areas. In case you need any clarification and assistance for internal audit of your company, our certified internal auditors at VA can assist you.

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