Steven Mugglestone

The more I learn, the less I know

Is an audit a boring waste of money or can it really add real value to a business?

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Is an audit a boring waste of money or can it really add real value to a business?

Rhetorical question, I know, but having been on various sides of the table for differing sizes of business, I think it is a relevant discussion point.

From observation and discussion and having returned back into the professional accountancy world, it seems that many SMEs can sometimes see an audit as either a necessary evil or just an “insurance policy” to have a name on their accounts in case somebody needs to refer to them for credit or banking facilities (or to sue).

It also appears that many accountants to SMEs treat it pretty much the same. Carry out an audit (all very nicely done and within the relevant standards and guidelines), but in the end they have a brief meeting with the client, arrange the formalities of various letters to sign and then that’s it done for another year.

Having worked as an adviser in a large corporate environment and as a Finance Director for a number of years, I do not believe that it has to be this way. An audit and in particular the resulting memorandum produced, can add real value to a business and provide real support.

The Key Issues Memorandum

A large formal audit environment and large audit firm may look to produce a Key Issues Memorandum document as either a by-product of the audit or to report specifically to the audit company of a large corporate client. This is likely to address the following:

  • To summarise and report on the key points from the resulting profit and loss, balance sheet and cash flow of the business
  • To address, report and conclude on any material issue that is significant In the year
  • To re-iterate the responsibilities of the director and auditors
  • To report that the company complies with the relevant legal framework to be able to sign an unqualified audit report
  • To report on changes on any other relevant and specific environmental or legal framework affecting the business
  • Maybe to explain the tax charge for the year
  • To report on any specific areas that the directors have asked the auditors to review
  • Maybe to report on controls, but more likely to report control problems
  • If really exciting to report on incidents of fraud perhaps
  • To report a list of minor or non-material errors found during the course of the audit

The thing is, these reports are very good, but for an SME business and business owner they could be better and even more useful.

The Commercial Finance Directors Key Issue Memorandum

Taking a Finance Directors view, we can take the concept of the key issues memorandum and make it far more commercial and of real use to businesses to be able to drive their business. Consider what a Finance Director would include:

Results for the period

Financial information is a measure, but are we measuring it against. If we sit down with a business first, the basic is what is the plan? Where are you now and where do you want to get to? To get to that position there will be stepping stones along the way. We need to consider the stepping stones and use them to guide and judge the business.

There is basic information that we can use. It does not have to a grand strategic plan; it can be done on one page. Whether it is sales, gross margins, percentages, number of widgets sold, cash generated, unit selling cost or production cost, telephone calls per hour, number of customers coming into a shop, sales per head etc., etc. these Key Performance Indications, KPIs, are vital markers to how a business is performing.

But what do we judge them against. Again, keeping things simple.

  • Prepare a 3-5 plan and highlight the KPIs in that plan, use them to judge on-going performance (amend them as you go, amend the plan as well, but do not throw it away, it is the framework of your business)
  • Prepare a detailed annual budget, use it to monitor and control the business throughout the year
  • Report the key changes from the budget and (more importantly), what is being doing to correct and amend these areas
  • Benchmark the results. All FDs will use benchmarking data to judge, review and amend their businesses performance. If your competitors are performing better than you, then you need to understand why and take appropriate actions.
  • We use benchmarking data from information from a UK wide database of financial information from accountants (not simply Companies House). We also use an easy “traffic light” method of benchmarking the performance against top, middle and bottom quartiles of similar UK wide business. If you are in the red, then we need to address that area, as 75% of your competitors already have done and are performing better than you. Moving up one quartile can have a significant effect on the performance.
  • KPIs are not only used to control and improve the profitability of a business; they should also be used to improve cash. Stock holding, debtor and creditor days and other working capital areas all impact on cash, and as any FD knows, when times get tough cash is king and when times get better, cash is still king.

Internal Controls

An auditor will look and report on an internal control in respect of potential fraud, areas where lack of controls may allow the opportunity to steal from the company. However, large audit companies are not whiter than white themselves in this area.

KPMG accountancy chief fiddled £545,000 to pay for his new wife’s £15,000-a-month luxury tastes
http://www.dailymail.co.uk/news/article-1208975/KPMG-director-stole-500-000-expense-claim-scam-fund-wifes-lavish-lifestyle.html

A Finance Director for an SME business may look at this differently and look at the area as controlled delegation, rather than internal control.

Controlled delegation is a more commercial approach and seeks to look at an area to free up the time of the entrepreneur/business owner from some of the area that they do not have to get involved with and allow and encourage them to spend more time on the areas that will enhance and grow the business. The controls need to be practical and allow the entrepreneur to work on the business, secure in the knowledge that those areas are appropriately controlled and reportable.

A practical example of how the information contained on an audit file and available for use by an auditor is as follows:

An entrepreneur was the main sales person for his business. He worked hard and was successful in growing sales, but in his opinion he was stuck, the business could not yet pay for another full time sales person, but the owner did not believe that he could increase the sales further in his own. On review of the monthly sales profile it could be seen that there was a consistent two months of good sales and one month of poor sales. On questioning the business owner it was ascertained that the product catalogue was quarterly and one month a quarter the owner would update the catalogue and not book so many appointments. A simple solution was that his assistant was trained to update the catalogue and report it back to the owner, allowing him to sell more. Needless to say sales increased and a future sales person was eventually paid for.

Internal controls are still very important. The report, however, should be able to come up with the practical controls that will allow the business to grow, but will also be able to highlight and recommend areas for improvement where the potential for fraud is high.

Risk register

Permanent Finance Directors, Contract and Project Finance Directors and Project Managers generally will all consider a formal risk register. Consider what can go wrong, rank them in the probabilities that they happen, rank them in respect of the financial impact to the business.

If it possible to go wrong and it has a significant financial impact, then what is in place to control and mitigate this, procedures, manuals, disaster recovery plans and insurance policies should all be considered.

A risk register that considers these areas, lists and puts in the controls for these areas is not only valuable, it is practically priceless. Generally audit procedures cover these contingent areas and can assist in the development of a practical risk register. Some of the areas, such as HR/IT control will have a practical solution and the controls can be outsourced, but the key is the risk register.

Tax area

This is practically a no-brainer. Yes the report should report on how the tax charge arises, but we can go further than that.

An audit gives insight to a business and practical tax planning can be applied to this knowledge. For example:

  • Tax advantageous pension contributions to key employees/directors
  • New product areas, new geographical areas and new markets may benefit from specific tax planning that can significantly mitigate the tax in this area for more than 5 years
  • Company cars and benefits can also be managed within a similar arrangement as those dealing with new growing areas
  • There are other tax strategies available, which will fit within the profile of the client and business, but the client needs to be aware of these
  • Build-up of cash in a business may look good, but for tax this needs to be appropriately addressed. A business should have a strategy for cash extraction. Dividend v bonus is a simpler one, but there are more.
  • Future tax changes need to be considered and appropriate strategies put in place. Again the audit and this document is a key tool to consider these areas and start an appropriate plan

The considerations can go further, but this is meant to be a short(ish) blog and capture some of the key points. An audit, a boring waste of money, with no practical use to the business, I do not believe so. SMEs should use an audit company that can call upon these valuable practical solutions and help while ensuring that the audit still results in the appropriate sign off of an audit report.

Without stating the obvious, I think we are one of this audit companies.
Steven Mugglestone BA FCA
West Midlands Area Director
McGregors Corporate

http://uk.linkedin.com/in/stevenmugglestonefca/
http://twitter.com/McGsCorporate
http://www.youtube.com/watch?v=nhC0wlglePE
http://www.mcgregorscorporate.co.uk/contact-us.html
http://www.mcgregorscorporate.co.uk/

T: 0845 519 5659
T: 0121 236 3317

steven@mcgregorsbirmingham.co.uk

Connect, call, talk, email, contact us, send a messenger pigeon and arrange a discussion, review and free meeting.

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Written by Steven Mugglestone

November 11, 2010 at 3:26 pm

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