Audits are essential for ensuring the accuracy and integrity of a company’s financial records. They provide a comprehensive review of an organization’s financial practices, internal controls, and compliance with regulations. However, when it comes to choosing the type of audit that’s right for your business, the distinction between internal and external audits can sometimes be unclear.
Understanding the key differences between these two types of audits, why you may need both at different stages and when to implement each in your organization is crucial for businesses of all sizes.
What Are Internal Audits?
Internal audits are conducted by employees within your organization. These audits assess internal controls, risk management, and governance processes. The goal is to ensure the efficiency and effectiveness of operations, compliance with laws and regulations, and accurate financial reporting.
Explore the difference between assurance vs. audit and forensic audits.
Pros of an Internal Audit
- Enhanced Controls – Internal audits allow you to identify and fix problems you’re not aware of, so you have greater confidence in the reports, forecasts, and strategies produced from those numbers. You can address issues quickly, reducing the size of the “mess” you may have to clean up.
- Continuous Improvement – You’re reinforcing the importance of accuracy and accountability in your team and fostering a culture of ongoing learning and growth within the organization.
- Flexibility – Internal auditors can focus on specific areas of concern as directed by management.
- Greater Frequency – Because internal teams run audits, you can conduct one as often as necessary and even follow up a concerning audit outcome with another audit to ensure the issue was adequately addressed.
- Confidentiality – You can keep the audit results inside the company for the most part.
- Define and Mitigate Risk – Reveal areas of concern and ensure controls are in place to manage them.
- Prepare Your Team for External Audits – These audits aren’t on your “official record.” This is one step you should take to prepare for a financial audit from a third party
Cons of an Internal Audit
- Potential Bias – Internal auditors may have a professional relationship (or personal friendship) with those being audited, especially in a small to medium business. They might subconsciously (or consciously) overlook problems because they think it’s not representative of a person’s work as a whole, defeating the whole purpose of the audit.
- Resource Intensive – Conducting thorough internal audits requires significant time and resources, not to mention pulling people away from their usual duties in smaller organizations.
- Limited Scope – Given the resources needed, you may choose not to audit everything you need to audit or feel overwhelmed by how much you have to audit, leading to the selection of a smaller sample size that isn’t representative of the whole.
- Employee Perception – Some employees may feel unjustly targeted or that they’re being blamed for findings when these audits aren’t about blame. They’re about fixing problems and enhancing organizational efficiency.
Working with the right CPA partner can help you overcome each of these challenges.
What Are External Audits?
Further contrasting the internal vs external audit, an external audit is performed by an independent third party, usually a CPA team. They review your company’s financial statements and compliance with accounting standards.
Learn the difference between audit and assurance services.
Pros of an External Audit
- Objectivity – This auditor has no invested interest in the outcome, allowing them to assess more objectively. They can provide an unbiased professional opinion based on their findings without concern about office politics or hurt feelings.
- Credibility – Financial statements audited by external auditors enhance credibility with investors, creditors, and regulatory bodies.
- Compliance – Some organizations are required to have a more credible external audit for investors and regulators. External audits ensure compliance with accounting standards and regulatory requirements.
- Detection of Fraud – No one wants to think employees are conspiring to commit fraud or making misstatements, but it can happen. External audits can all but eliminate this possibility. Beyond the external audit itself, the potential of an external audit on an unknown date could keep people who may entertain the idea of misstating the numbers in line. However, this only works if you complete an external audit at some point.
Cons of an External Audit
- Cost – External audits can be expensive, particularly for small businesses. However, there are some ways to reduce these costs.
- Disruption – Having external auditors in your systems or in the physical building can feel disorienting to the team. Some normal business operations may need to hit pause during parts of the audit to get the auditors what they need.
- Limited Understanding – External auditors may not fully understand the intricacies of the business’s operations, industry, procedures, and culture. This could lead to misunderstandings.
Working with the right CPA partner can help you overcome each of these challenges.
Similarities Between Internal & External Audits
The goal is the same in internal vs external audits. Both aim to ensure accurate financial reporting and compliance with regulations. The process is also similar, with both requiring the systematic examination of financial records. Finally, both will follow established standards based on generally accepted accounting principles (GAAP) and well-respected methodologies.
Differences Between Internal & External Audits
Now, let’s break down the key differences. First, there is scope. An external audit focuses more on the end product, which would be the accuracy of financial statements. Internal auditors are more concerned with how you’re getting to those numbers with internal controls, risk management, and operational inefficiency.
Second, one is independent. They have no invested interest in the audit results.
Third, one reports to internal management with the potential for promotions, demotion, or firing, each an unspoken factor that could influence the results. The other does not have these ties or concerns.
Finally, you can perform internal audits more frequently and focus on specific areas if you prefer. External audits should be unfettered to allow for honest and thorough analysis. That’s a key difference between internal vs. external audits.
Ensure Financial Health with DHJJ
Both internal and external audits play vital roles in maintaining the financial health and transparency of your business. At DHJJ, we understand the unique challenges and opportunities that come with managing your company’s finances. Our team of experienced professionals is here to help you navigate these complexities and ensure your business’s financial integrity. Ready to secure your financial future? Contact DHJJ today to schedule a consultation and learn how we can support your business’s growth and success.