Business complexities seem to grow exponentially. Emerging technologies form in the background, ready to disrupt operations. Finding the talent to mitigate the upheaval that advanced technology can cause remains challenging. Add an uncertain economy to the mix, and companies face a growing number of financial risks. Identifying major risks through an internal financial audit enables organizations to mitigate them. For example, an audit team would assess financial data security. As part of that assessment, they would look at cybersecurity. If a business does not have a risk management plan for deploying new technology, the risk auditors would note that as a financial audit risk.
Cybersecurity is just one of the major financial audit risks. Others include:
The following list discusses how these risks can develop and the mitigating strategies to use to reduce their financial impact.
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Cybersecurity Threats
The statement that every company is a technology company has never been more true. Businesses are moving some or all of their operations to the cloud. They are deploying more software solutions and increasing external access points for remote work. This expansion creates a larger attack surface for cybercriminals to compromise.
Companies need to update their security protocols to reflect changes in their infrastructure. If they lack the expertise to deliver robust cybersecurity measures, they should look at outsourcing their cybersecurity to experts. The latest report on the financial impact of data breaches estimates the cost to be $4.45 million (US). According to the report, system complexity, skills shortages, and noncompliance were the major cost amplifiers.
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Regulatory Compliance
Organizations face a myriad of regulatory standards, including employment and labor, environmental, and privacy laws. Failure to comply with any of these standards can result in financial penalties. However, staying up to date on regulatory changes can be overwhelming.
Companies should offer compliance training for employees, and internal audits should be conducted regularly. Policies and procedures should be updated to reflect current standards. If companies lack interest resources, they should consider outsourcing. Having a documented reporting framework can mitigate many risk areas.
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Data Privacy Requirements
Although they may not make the headlines, data breaches still happen. In 2023, almost nine data breaches occurred per day in the United States, exposing the personal information of 353 million people. If the breaches resulted from noncompliance, the cost could increase by the thousands.
With the increase in data privacy laws, the risk of a noncompliant breach rises. For example, the European Union's privacy law -- General Data Protection Regulation -- applies to any online organization that does business with an EU member. The regulations are based on the consumer's location rather than the business's.
While the United States does not have a federal privacy law, more states are creating regulations. As individual states implement privacy laws, complying with rules becomes even more complex. California's legislature passed the California Consumer Privacy Act (CCPA), which follows the EU's model, placing jurisdiction with the consumer and not the business.
As with cybersecurity and regulatory requirements, internal data privacy audits should be performed systematically using defined audit procedures. Weaknesses should be identified, and potential risks should be quantified to determine how to address them. If internal resources are unavailable, outside resources can conduct audits and develop data governance policies.
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Supply Chain Disruption
When supply chain became a household word, it also became a major financial audit risk. Companies waited weeks for container ships to clear port and suffered significant losses. A 2022 survey found that 57% of businesses reported substantial losses because of supply chain disruptions.
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62% indicated that the losses were financial.
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54% found that they experienced logistical losses.
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54% stated that they suffered damage to their reputation.
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Yet, only a small percentage (6%) have end-to-end supply chain visibility.
Disruption is not always external, such as natural disasters or geopolitical changes. Declining quality or on-time delivery may go unnoticed unless businesses monitor their suppliers using analytical procedures. Supplier risk management processes should be in place to protect against cyberattacks, identify diverse suppliers, and outline alternative delivery routes.
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Revenue Recognition
Most businesses use accrual-based accounting, which recognizes revenue based on when goods or services are earned, not when payment is received. This distinction can often result in inaccurate revenue values through misinterpretation or errors. For example, a custom software development company requires a deposit before starting work. The payment appears as cash on hand, but the revenue may not be recognized until work begins.
Using automated systems can help regulate revenue recognition. Parameters can be set to ensure revenue is only recorded when all requirements are met. Adjusting accounting procedures as business evolves minimizes the risk of an inaccurate statement. Outsourcing revenue recognition processes to industry professionals can help mitigate the risk.
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Financial Reporting Accuracy
Business decisions should be data-driven, but the decisions are only as good as the data. If financial information is faulty, decisions based on the data will be unreliable. Data entry errors can cause inaccurate reports, and complex transactions can test an employee's knowledge of an accounting system. Poor communication and a lack of oversight can complicate the reporting process.
Automating financial reporting can help deliver timely reports. Dual-entry accounting software can help with reconciliation for improved accuracy. Internal audits should occur at set intervals to ensure accounting policies are correctly implemented or updated to reflect changes. Outsourcing financial reporting and auditing to experienced professionals can help provide an added layer of objectivity and identify possible fraud.
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Tax Compliance
No organization wants to experience a tax audit. Not only are they stressful, but they also consume valuable resources. Staying current on tax laws and their application can help with tax planning, minimizing the risk of unexpected tax liabilities. Without accurate financial reporting and appropriate revenue recognition, tax-related risks are unavoidable.
Outsourcing tax compliance and planning to professionals can mitigate the risk of a tax audit. Third parties provide another perspective on interpreting tax law and identifying the appropriate documentation to support your tax returns.
Mitigating Major Financial Audit Risks
Increased business complexities require a proactive approach to risk management. Whether it's potential fraud or a reporting error, knowledgeable risk auditors will apply an audit risk formula to establish an organization's overall risk. The audit risk formula determines the risk for an audit area using the following formula:
Audit Risk = Control Risk * Detection Risk * Inherent Risk
where
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Control risk indicates the potential that a material misstatement would not be detected.
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Detection risk looks at aggregated audit procedures to determine if a potential risk can be detected.
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Inherent risk is the likelihood of misstatements because of a lack of internal controls.
Knowing the audit risk of an audit area allows organizations to determine if the potential risk is acceptable or whether mitigating strategies are needed.
Businesses should be proactive with their risk management efforts, which may include outsourcing some or all of their financial risk assessments. If your company could benefit from outside assistance, contact Personiv to learn how our finance and accounting outsourcing solutions can help you navigate these risks and achieve financial stability.
