Consider that the U.S. equity markets are on pace to have their worst month since 1931. That means that the stock market in March 2020 has plunged further than any month preceding the U.S. recessions of 1949, 1958, 1973, 1990, 2001, or even the Great Recession of 2007–2009. Markets across the world are seeing similar economic impacts. In my view, the conversation is no longer whether we are facing a recession. Instead, the question is how deep will it be, and how long will it last?
So what does all of this have to do with internal audit? Having experienced at least six recessions during my career, I know that economic downturns offer both threats and opportunities for internal audit. Organizations facing severe pressures on the bottom line often disproportionately and foolishly penalize internal audit when making budget and staffing reductions. In 2009, for example, 35% of Fortune 500 internal audit departments lost staff. In a blog post only two months ago, I warned of this possibility and urged internal auditors to clearly articulate their value to their organizations before the next recession.
We now must turn our attention to demonstrating how internal audit can help organizations navigate the looming economic downturn. As a profession, we are duty bound to "follow the risks." When pressure on the bottom line (and potentially even the survivability of the organization) becomes a primary risk, we need to roll up our sleeves and get to work. At The IIA's Global Headquarters, our internal audit resources have been focused for almost two weeks now on examining the pandemic's short-term and long-term fiscal impact on the organization.
In 2009, the world was experiencing the depths of the worst financial crisis in 70 years, and internal auditors focused then on identifying cost reductions as well. I went back to an IIA survey from late 2009 to gain some perspective on where they found the most success. These were the five areas:
- Vendor payments.
- Contract compliance/administration.
- Organization control structure/span of control.
- Construction and capital projects.
- Revenue assurance.
However, before you launch into extensive efforts in these five areas, make sure you do it right. In 2010, Harvard Business Review offered advice in an article, "When You've Got to Cut Costs — Now." The authors made two very astute observations:
"First, forget about finding a single idea that would radically change the cost structure of your organization or department, thereby solving your problem in one go. (If such an idea existed, it would most likely entail so much risk that the organization would never be willing to implement it.) Instead, you should plan to reach your goal with a combination of 10 or more actions."
"Second, the degree of organizational disruption caused by your reductions will usually be proportional to the degree of cutting you do."
The authors provided these specific ideas to achieve the easiest 10% reduction in costs:
- Take overdue personnel actions.
- Reduce spending on department management.
- Gain control of "miscellaneous" spending.
- Hold down pay increases.
- Re-propose rejected cost-saving ideas.
None of these are radical or new ideas, but they can be very powerful when implemented quickly.
However, it is important to recognize that many cost-saving actions can impact future risks. Cutting the wrong costs can result in subjecting the organization to unacceptable risks in the future. There needs to be a balance between needed cost reductions and effective risk management going forward (e.g., sufficient internal controls over contracts and vendors).
The purpose of this blog is to spur internal auditors to take steps now in response to the looming imperative to reduce costs. I encourage every internal audit department to immediately start a dialogue with management and the audit committee about the emerging risks that a recession may bring. Approach the conversation with ideas about how internal audit can help now, and in the future.
The current health crisis is unprecedented in modern times. Internal audit will be tested once again to prove its value by identifying and responding to risks brought on by the pandemic in a way that supports the organization best. This is not a short-term "project" for internal audit. Indeed, the related risks will likely continue well into next year and change dramatically over that time. This will require internal audit to continue to be agile, adaptive, and responsive. Our organizations deserve nothing less.
I welcome your ideas on ways internal audit can help organizations facing pressures on the bottom line.