An operational audit is an examination of the manner in which an organization conducts business, with the objective of pointing out improvements that will increase its efficiency and effectiveness. This type of audit is substantially different from a normal audit, where the objective is to examine the adequacy of controls and to evaluate the fairness of presentation of the financial statements.
Operational audits are usually conducted by the internal audit staff, though specialists can be hired to conduct reviews in their areas of expertise. The primary users of the audit recommendations are the management team, and especially the managers of those areas that have been reviewed.
Businesses can get a decent idea of how they are doing in operations by examining internal company data through reports and graphs. However, sometimes those close to the company don't review this data with total objectivity, or are so familiar with operations that it is difficult to come up with alternative solutions when roadblocks appear.
To truly gain a good picture of whether the company is operating well and get fresh ideas of how to improve, businesses and other organizations may turn to the operational audit process.
Operational Audit Process Definition
An operational audit process is the series of steps an auditor takes to evaluate the operational activities of a given company or other organization. The process is similar to the processes for other audits, but more in-depth: For example, in a financial statement audit the auditor is typically dealing only with numbers and accounting practices, while in a an operational audit the auditor may be examining any aspect of the business.
The audi does not usually focus on a single department or project, because each department plays a role in the overall operational process and is interconnected.
Goals of an Operational Audit
The goal of the operational audit process is to determine whether the internal controls of the business, such as policies and procedures, are sufficient to produce an optimum level of efficiency and effectiveness.
This is critical for businesses, because a lack of efficiency and effectiveness typically translates to fewer sales or increased operational costs, which sometimes mean the inability of the business to compete and stay in business. Other organizations may use an audit to determine whether an entity is following specific laws, such as privacy regulations or even sanitary practices, depending on the state of their industry.
Common Operational Audit Steps
During preaudit, the auditor meets with managers, explains the audit process and gathers basic information about the company to determine concerns and risks.
Next, the auditor meets with key managers to verify the components of the audit and the associated concerns. Specific goals for the audit are developed at this stage, such as meeting a certain industry standard, or increasing sales to a competitor's level.
Fourth, the auditor designs and prepares testing procedures for each key control. He reviews the plans with managers and carries out the tests, documenting and discussing all results and improvement proposals.
Then the auditor drafts a complete audit with specific recommendations and implementation option. The auditor goes over this report with management until it is clear that management knows how to address the issues found. A final report is often created summing up the total audit, and depending on the auditor, there may be follow-up, additional workshops, or a final exchange of helpful materials.
Advantages and Disadvantages of an Operational Audit
Going through the operational audit process provides a company with objective opinions. Those opinions often generate quicker production or sales turnaround, better allocation of costs, improved control systems, the location of areas of delay and an overall streamlined workflow.
However, similar to any audit, operational audits cost money to perform. Those involved in the audit cannot be engaged in other operational processes when they are meeting with the auditor or gathering data for the auditor to use.
Additionally, operational audits take considerable time to complete, and it can be harder to determine exactly what is causing problems the more complex operations are. Even though overhauling operations based on audit results may save the business money in the long run, doing so can rattle employees, cause initial confusion and necessitate increased training or significant staffing alterations.
An operational audit is a formal evaluation of the internal systems and procedures a company uses to produce goods or services. Made of at least four major steps, it tests how efficient and effective production operations are, which ultimately boosts revenue and profits. It also can reveal ethical issues in the business. External or internal accountants may perform the review, based on the needs of the business. This process has some disadvantages, such as potentially high cost, but it also offers advantages, such as new perspectives and increased risk awareness.
Purpose
One of the first steps of an audit is to meet with the managers of the company to determine the objective's of the process.In general, the tools and processes a business uses to get a product or service to the public have to work as intended and be efficient. When they aren't, the company usually can't make as much money and can't be as competitive. Businesses, therefore, use these types of audits to streamline what they're doing, with the ultimate goals being to decrease waste and boost revenue and profits.
Similar to other reviews, looking at how the company is functioning overall can uncover ethical problems, such as employees using company property for personal reasons. The results of the audit let managers identify who is involved in dishonest practices, which often leads to greater accountability on the job. Companies' disciplinary and general policies often connect closely to the review for this reason.
External Auditing
Audits often take place in an attempt to save a company money.Staff accountants from public accounting firms usually conduct operational audits. These professionals are not otherwise associated with the businesses they audit, so they can provide a fairly objective opinion. Stakeholders often prefer using their services to internal auditors to get information because of this lack of bias, but hiring an outsider usually is more expensive.
Internal Auditing
In some cases, it is a better option to have someone from within the company go through the review process. Companies usually turn to internal audits when executives want a more continuous picture of what's going on in the business, sometimes going through several audits each year to stay innovative and keep revenue high. Although many employees are able to be honest and objective in an operational audit, some are not. Relying on an employee to perform the job carries the risk that the ending figures or analysis won't be entirely accurate, because an individual sometimes gets a bonus or pay increase based on how good the results are.
Administration
Accountants look at administrative departments during these types of audits, as well. These areas can increase costs by employing too many individuals or having an improper workflow. Changes in teams, policies or administrative equipment sometimes result at the conclusion to fight these problems.
Cost Allocation
Cost allocation refers to the process of figuring out what a company needs to operate and determining the common price for each of those items. It usually is based on using similar materials and labor to produce goods and services consistently. These methods have to be accurate in order for the business to earn high profits. Auditors review these methods because factors such as poor quality material and untrained labor can slow production and decrease profits.
Scheduling and Time Efficiency
Operational audits focus on decreasing the amount of time needed to produce and deliver goods or services to retailers and wholesalers, because delays result in fewer sales and increased business costs. Sometimes, the problem is as simple as poor scheduling or communications, but factors like outdated equipment or a low number of employees can also contribute to slowed production. These issues are more critical because they might require drastic changes to the company's budget, policies or standard methods.
Audit Steps
Staff or internal accountants generally go through a standard set of steps when they conduct an audit of this type. In the first step, the accountant meets with leaders within the company to determine exactly what the scope of the process will be. This includes setting specific goals and objectives, as well as gathering some basic information about the business, such as its policies and history. The auditor develops a formal plan for how and when the rest of the audit will happen.
Once the auditor has some background information and knows what the process is supposed to achieve, he observes and schedules formal meetings with managers. They discuss operations in depth, including whether workers are meeting expectations. From here, the accountant moves on to similar meetings and observations of the employees, getting their side of the story and departmental details. This is the fieldwork stage of the audit.
Following the manager and employee fieldwork, the auditor goes over all the information he's collected, tests as many processes as possible and analyzes his results. He writes a report about what he found, ending with some suggestions for how the company might address any problems. Depending on the scope of the process, these reports can be quite long.
At this point, the accountant meets with managers again and presents his report, discussing its content. The business leaders have a chance to respond to the findings and provide reasons if they don't think they can carry out any of the suggestions for improvement. The auditor usually schedules a follow-up audit at this meeting or very soon after, which usually takes place about six months after the main one. The follow-up gives executives and the accountant the opportunity to see if progress has been made.
Disadvantages
Reviewing operational processes can be very time consuming and costly. When employees and managers are working with the auditor, they can't do other activities that might benefit the business, so projects or production might slow temporarily. Sometimes, the changes that a business makes are hard for workers to get used to, which can increase conflicts or confusion.
Advantages
In addition to making the business more efficient and profitable in the long run, an operational audit almost always provides a company with some new, fresh perspectives. It makes executives aware of problems that might not have been found otherwise and lets them evaluate risks for the future. Managers also can use results to motivate employees, as the company always has something to work toward at the end of the process.
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Discussion Comments
What if as an internal auditor, you empower the department managers to do their own daily, weekly, monthly audits so that they as those in the trenches are always aware of what they could be better? You know, train them to analyze their department's numbers, processes, reasonable expectations, and such. And of course, as mentioned, be open to employees' recommendations.
@allenJo - I think another problem is the gap between industry knowledge and what the auditor knows. For specialized industries, such as engineering, it becomes difficult to imagine how an auditor can improve processes except in a general sense. The employees themselves may have a better idea on how to cut costs and improve procedures, since they muck around in the trenches all day long. Therefore management needs to spend some time listening to the employees and ask for their advice, as you said.
The suggestion box needs to become more than a polite nicety. It needs to be something that really empowers employees to know that they can make a difference in how their company is run. When this kind of cooperation happens at the lower rungs then true improvements will begin.
@NathanG - I agree with everything you said. None of those outcomes help the company in any way. That doesn’t mean the auditor’s job is useless or not practical. It does mean, in my humble opinion, the first order of business for a compliance auditor should be to establish trust with the employees.
He should meet with them individually and build some rapport. Most of all, his first priority should be to listen before even thinking of making suggestions. Otherwise, he will wind up making recommendations to management that get dispensed to employees but don’t get implemented, not in a way that brings meaningful improvements.
In our company the problem has been more to do with egos than anything else. From the perspective of the employee, here is this auditor stepping in to evaluate processes and tell people how to do their jobs better. He has this operational audit checklist he has to tick off, and based on this he makes suggestions.
The employee either butts heads against these “suggestions,” or worse, does them out of sense of fear—thinking his job may be on the line. So a sense of panic sets in, and while he wiles away at his job duties he secretly plans an exit strategy.
That's what I thought it was. Realistically, though, I think compliance with such audits tends to slow production, at least that's been the case in my experience.
Though I understand why they do what they do, and I'm sure that audits do prevent problems in some cases, the auditors that I have had interactions with tend to focus more on theoretical solutions that don't really work out practically in the every day running of a shop.
I'd love to hear about others people’s experiences with these things though -- maybe I just have had bad experiences.