What is an Internal Audit?

An internal audit is an independent and systematic appraisal function performed within a company. It is an unbiased, objective evaluation of the company's inner workings and processes. An in-house audit team mostly conducts it, but it can be outsourced to teams directly reporting to the board of directors.

An internal audit’s core purpose is to analyse daily operations within an organisation, identify gaps, and offer suggestions for improvements based on these gaps.

Internal Audits Key Features

Knowing the main features of internal audits helps businesses use them better. Here's a quick look at why they matter for good control and decision-making.

Internal Audit Purpose

Assessment and improvement of internal workings are at the core of internal audit. This type of audit helps lower risks and enhance the company's operations.

Focus Area of Internal Audit

Internal audits focus on compliance, governance, fraud detection, improvement of processes and adherence to company policies. They also help evaluate accounting systems and routine operations.

Conducted By

It is conducted by an in-house team, or external consultants are hired to work on behalf of the company.

Frequency of Internal Audit

Internal audits can be ongoing or can be performed at regular intervals as per the organisation’s requirements.

Audit Reporting

When the internal audit is complete, a report with observations is shared with management. With this analysis, the company can take corrective measures to close the gaps.

Benefits of Internal Audits

Internal audits do more than just check compliance — they add real value to a business. There are many benefits of internal audits. Let’s take a look:

Identifying Risks

Internal audits help to detect fraud or potential fraud, inefficiencies, risks, etc. before they escalate into bigger issues.

Optimising Processes

Audits help to boost workflows, unclog bottlenecks and improve cost efficiencies.

Governance and Compliance Readiness

Regular audits help ensure that businesses comply with the latest government regulations and stay updated with industry standards.

Constant Improvements

Audits help organisations identify policy refinements, risk management strategies and internal controls.

An internal audit aims to boost the organisation's value through smooth operations and monitor internal controls through regular checks and risk management systems. Internal auditors are company employees but a separate department in the organisation, working on audits throughout the year.

What is an External Audit?

External audits are independent and conducted by third-party agencies or teams hired by the organisation. They help analyse the organisation's financial health by thoroughly checking the statements and accounts. They examine accuracy, test internal controls, and highlight potential risks and fraud.

External audits assess an organisation’s internal workings and offer insights and in-depth analyses of its financial health. With them, organisations can maintain financial transparency and adhere to regulatory standards.

External auditors should not be connected to the organisation, as this helps to avoid conflicts of interest and ensures that the evaluation can continue without bias.

External Audits Key Features

To understand how external audits support transparency and trust, let’s explore their key features:

Purpose

External audits help to verify financial records and ensure that the organisation complies with all the statutory regulations and standards of accounting.

Conducted by

External audits are performed by independent external auditors or a professional auditing firm, which is not an employee of the organisation that is being audited.

Focus Areas of External Audits

External audits focus on the accuracy of compliance with regulatory frameworks, financial records accuracy and fraud detection.

External Audit Frequency

An external audit can be conducted once every year or annually, or as required by the stakeholders or by the law.

Audit Reporting

Insights and findings are first documented in a report and then shared with the regulators, company stakeholders, and investors.

Benefits of External Audits

With external audits, an organisation gains many benefits, the most important being market credibility, transparency, better compliance with statutory regulations and insights into risks and issues. Let's take a look at the benefits in more detail:

Financial Accuracy

External audits make sure that an organisation’s financial health is reliable, it is clear of any mismanagement or misdeed, and it is compliant with industry standards.

Boosts Investor Confidence

An external audit offers an objective evaluation of the company's financial health, and this helps to strengthen the trust of shareholders and stakeholders of the company.

Regulatory Compliance

Regular external audits help organisations meet statutory requirements and avoid unnecessary penalties.

Prevention of Frauds

The core purpose of external audits is to identify financial mismanagement or fraud, which could lead to legal hassles.

External audits are a must for any organisation that wants to establish and strengthen its market value. It helps to gain trust among stakeholders with accurate financial reports, boosting credibility and compliance with industry regulations.

Internal Audit vs External Audit: Which is Better?

On the outside, an audit, external or internal, may seem to make no difference. However, the scope of internal audits and external audits does serve different, crucial purposes. Both are important for an organisation as they help to boost and optimise the organisation’s health.

Let's understand the difference between internal and external audits in tabular form:

If asked which is better, internal audit or external audit, the answer would be that they both have complementary roles for the organisation. They help maintain regulations and the financial health of the company.

Related: Understanding Financial Statement Audit

The Role of Internal & External Audits in Risk Management

Most organisations prioritise risk management. Both types of audits play crucial roles in managing risks. Let's take a look:

• Internal Audits highlight the gaps in business operations and offer solutions to improve efficiencies, risk mitigation strategies, etc.
• External audits offer an objective financial assessment of the organisation. They help in reducing potential fraud and improving regulatory compliance.
• Transparency in financial records and improved operations help to strengthen the market value of the organisation and improve market reputation.
• Internal audits help identify regulatory discrepancies and manage compliance risks proactively.
• While external audits are often conducted for financial evaluations, their frequency depends on regulatory requirements.
• Some organisations undergo annual external audits, whereas others may have different schedules based on industry standards and compliance needs.

Both internal and external audits are important for organisations.

Do Businesses Need Both Internal and External Audits?

While different teams conduct internal audits and external audits, the relationship between the two is important. External audits are required by law, and internal audits help to ensure that the company is healthy from within. Internal audits help identify risks, fraud, and compliance issues before an external audit is conducted. Therefore, both are crucial.

Here's why businesses need both internal and external audits:

• Internal and external audits complement each other. Internal audits prepare the company by identifying gaps in compliance and inefficiencies, thereby mitigating the need for external audits.
• Regular and timely internal audits help strengthen internal control, thereby reducing the likelihood of financial mismanagement.
• External audits are smooth and seamless for organisations that invest in strong, robust internal audit teams.
• Through internal and external audits, organisations can achieve success, maintain market credibility, boost investor confidence, and adhere to statutory regulations.
• With continuous internal audits, organisations can lower the risks of financial fraud before external audits catch them.
• Audits ensure accountability and transparency in a company's operations. This helps build trust and foster better relationships with stakeholders.

Yes, businesses need both internal and external audits. Together, they are an effective combination to ensure accurate, transparent financial records, boost credibility and achieve operational excellence.

Conclusion

Internal audits and external audits play a significant role in the success of an organisation. While external audits offer financial accuracy and help with regulations, internal audits focus on managing risks and improving internal operations.

Organisations need to understand the need for both types of audits and leverage them to manage their stakeholders' expectations and trust, ensuring sustained growth. A proper audit framework helps to establish strong financial integrity, reduce risks and reiterate the organisation's commitment to compliance.