Strategic Planning for 2011? Changes in Business Can Compromise the Effectiveness of Internal Controls

If we have learned anything from the Sarbanes-Oxley era and the scandals that brought down the economy, it is that internal controls have to be effective. The first step is control design. When done properly, the design will include preventive controls to preclude undesirable activities and detective controls to alert management when exceptions occur. An appropriate design of preventive and detective controls is critical, but not sufficient. Control environments are dynamic. Changes in the business often result in workload shifts. When this happens, roles and assignments are informally swapped to make the work load more equitable. As informal process changes evolve, the control design is often unintentionally compromised, sometimes with significant consequences.

For example, an Accounts Payable Manager has the responsibility to review all vendor master file changes before payments to vendors are made. However, if the Accounts Payable Manager is suddenly swamped with a new system implementation she may not have the time to review the master file changes and she may not be available when the payable checks are ready.

In situations like this, the Accounts Payable Manager might assign the vendor master file review to an employee who is responsible for processing checks but does not have system access to enter invoices. On the surface, this appears to be a viable alternative since the responsibilities for invoice processing and vendor change review are segregated. However, this informal role change has just compromised the control system.

What happens if this employee creates an invoice from a fictitious vendor? Since the employee has been given the responsibility to review new vendor additions, the fictitious vendor is not questioned. After the invoices are processed, she simply prints the check and pockets the payment.

This is only one example to illustrate how a “quick fix” may not be in the best interests of the company. Informal reassignments are common as new pressures develop. When workloads shift, it is worth the time to review the internal control design in total. If there is no time for a total control design reevaluation, enlist the help of the Internal Audit department. In any case, when responsibilities are reassigned make sure that there are adequate mitigating controls throughout the entire process. Having “trusted” employees does not always protect against errors or fraud.

‘Tis the Season to be Internal Audit Planning

As the holiday season is rapidly approaching, good tidings are regularly shared as should be the case.  It is time to be joyous and celebratory for the year that was and hopeful for the year that shall come.

It is also a time for Internal Auditors to take stock in their year that was and plan for the year that shall come.  I presume most Internal Audit Departments have completed their annual risk assessment, are trying to wrap up any remaining items from the 2010 Internal Audit schedule, and are putting together their 2011 Internal Audit Plan.

Here are some questions I recommend Internal Auditors ask themselves:

• How has the economy impacted the audits I complete?
• How responsive is my audit plan to changes in risks?
• How was the 2010 plan better than the 2009 plan and how is 2011 going to improve upon 2010?
• What were my significant accomplishments in 2010?
• Were these accomplishments significant to only me or did they have a profound impact on the company?
• What significant accomplishments are going to be made from the 2011 audit plan?
• How is the 2011 audit plan going to enhance the strategic relevance of Internal Audit?

The easiest thing to do is keep everything the “same as last year” - and there could be logic in it like... the economic conditions, staffing shortages, resource constraints, regulatory requirements, and so on.  But, the CEO can’t go to the Board and say "the company's 2011 strategic plan is the same as our 2010 plan" and neither should the Internal Auditor.  Take whatever flexibility you have and think strategic, think relevance, and think profound impact.  Successfully do that now and in 12 months the 2012 planning will become much more fun!

For more information on Internal Audit’s strategic role please review The 2010 Report on the Strategic Role of Internal Audit.

Maximizing the Asset: Inventory Management in a Sluggish Economy

If you are experiencing shrinking margins, cash flow may become your primary concern. Increased sales will produce increased cash input, but purchases and investments lead to cash outlays, and what about inventory? Inventory sits in the warehouse. Inventory not only freezes cash flow but generates expense by requiring handling and storage space. Unless it is on the way out the door to a customer, inventory contributes nothing of value to an organization.

Inventory management is a tradeoff between the ability to meet customer expectations and the necessity of keeping assets fluid to meet unexpected demands and higher costs. Before investing in more storage space or warehouse management tools, consider using resources in ways to decrease inventory.

1. Time is money
The inventory level needed to achieve a given customer fill rate is roughly related to the square root of the lead time. That means that if all other impacts are the same, inventory levels can decrease by 50% when the lead time shortens from four weeks to one week.

One of the strategies to reduce lead time is to develop the ability to customize products at the final stages of production. This allows for the flexibility needed to respond to changes in customer demand. This not only reduces the lead time, but decreases the risk of producing the wrong products.

2. Forecasts are always wrong
Forecasts, by definition, will always be wrong. If forecasting must be used, avoid using financial projections to plan production. Although finance is a vital function in any organization, financial projections do not capture demand. Understanding demand is the key to having the right products in the right places. If a demand forecasting and deployment system is not in the budget, a simpler spreadsheet model can be used quite effectively. Even better, develop relationships with customers to directly access their needs.

3. Negotiate with vendors
Many vendors will manage inventories. Some will replenish daily, leaving only a small safety stock on the premises.

4. Standardize components
Fewer components needed across product lines mean a lower overall inventory. Examine the bills of material for similar types of components and work with engineering to consolidate wherever possible.

5. Get rid of obsolete products and components
Obsolete parts take up valuable space and require handling. If a component is custom made and may be used in the future to service product, move it to after-market stocks. Otherwise, find a buyer on the internet or simply throw the parts away.

The value of an investment in inventory is measured only by how quickly it disappears. The optimal amount of inventory is no inventory at all. This is not a realistic expectation, so the next best strategy is to minimize it wherever possible.

To conduct an audit of your inventory management process, give us a call.