When you receive a management letter with your audit, how many recommendations do you follow up on? Tackling the major issues can be sufficient. However, going on a deeper dive with your auditor can help your business improve overall.
Drew Bolog, a manager at 415 Group, explains the importance of not only following up on your auditor’s notes, but also following through on the recommendations.
Maintaining the status quo in today’s volatile marketplace can be risky. To succeed, businesses need to “level up” by being proactive and adaptable. But some managers may be unsure where to start or they’re simply out of new ideas.
Fortunately, when audited financial statements are delivered, they’re accompanied by a management letter that suggests ways to maximize your company’s efficiency and minimize its risk. These letters may contain fresh, external perspectives and creative solutions to manage supply chain shortages, inflationary pressures and other current developments.
Auditing standards
Under Generally Accepted Auditing Standards, auditors must communicate in writing about material weaknesses or significant deficiencies in internal controls that are discovered during audit fieldwork. A material weakness is defined as “a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis.”
Significant deficiencies are generally considered less severe than material weaknesses. A significant deficiency is “a deficiency, or a combination of deficiencies, in internal control that is … important enough to merit attention by those charged with governance.”
Auditors may unearth less severe weaknesses and operating inefficiencies during the course of an audit. Although reporting these items is optional, they’re often included in the management letter. The write-up for each deficiency includes an observation (including a cause, if observed), financial and qualitative impacts, and a recommended course of action.
From compliance to business improvement
Audits should be more than just an exercise in compliance. Management letters summarize lessons learned during audit fieldwork on how to improve various aspects of the company’s operations.
For example, a management letter might report a significant increase in the average accounts receivable collection period from the prior year. Then the letter might provide cost-effective suggestions on how to expedite collections, such as implementing early-bird discounts and using electronic payment systems to enable real-time invoices and online payment. Finally, the letter might explain how improved collections would potentially boost operating cash flow and decrease write-offs for bad debts.
When you review the management letter, remember that your auditor isn’t grading your performance. The letter is designed to provide advice based on best practices that the audit team has learned over the years from working with other clients.
Observant auditors may comment on a wide range of issues they encounter during the course of an audit. Examples — beyond internal controls — include cash management, operating workflow, control of production schedules, capacity issues, defects and waste, employee benefits, safety, website management, technology improvements and energy consumption.
Take your audit to the next level
Always take the time to review the management letter that’s delivered with your audited financial statements — don’t just file it away for a later date. Too often, the same talking points are repeated year after year. Proactive managers recognize the valuable insights these letters contain, and they contact us to discuss how to implement changes as soon as possible.
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As an auditor, I’ve seen the importance of management letters. Their recommendations are very helpful when provided with an audit or later on, yet not every business owner understands their value. Let’s take a deeper dive, so you’ll know what to do the next time you receive a management letter.
Every audit comes with a management letter, whether we are working with a corporate entity, non-profit organization, employee benefit plan, or any other form of audit. The formal letters include notes we are required to put in, like material weaknesses and significant deficiencies that clients should quickly address.
We also include additional risks and items we notice while performing the audit, along with things we look at for specific industries and businesses. We don’t strictly look at financials, but anything that can impact the business’s bottom line that we believe merits management’s attention. Finally, we include forward-looking items to ensure potential control issues are on your radar if we believe a currently small issue has the potential to grow in future years.
In reality, these letters can include notes about any aspect of the business or organization we feel needs a second look before the next audit. For example, we can point out a department that may be understaffed. It might not be a current major issue, but if one person can’t keep up with the workload, then this could create a risk that an internal control may fail—which can definitely begin to create problems.
At times, those who receive management letters can feel like they are being graded or getting in trouble. Yet the opposite is true – we point out any issues we see, along with items that could become an issue down the road, in order to help you see the things you might not notice in day-to-day operations. We want to help you succeed, which is why we recommend addressing the items in the letter as soon as possible.
Some items really do need addressed with urgency. But there are others that can be sorted out later on. What we don’t want to happen is that we notice the same issues popping up year after year. Not only can this create a huge problem in not addressing the risks themselves, but it can also signal that management or those charged with governance are not willing to take recommendations on improving controls.
Management letters are one of the last formal pieces of our audit. Businesses receive them after the entire audit process is complete, so there is a tendency to put them to the side to look at later. We recommend scheduling a meeting with us to go through the letter in order to ask any questions you may have and to get clarity on high-level details.
By allowing us to expand further, you can tap into our ever-expanding knowledge built from decades of experience in a variety of industries, businesses and non-profits. We can assist in determining a plan of action and may even be able to connect you with others that have been through similar situations who can help you improve controls or put in safeguards for potential future issues.
When you work with trusted advisors and observant auditors like those at 415 Group, you’ll see a positive impact on your business. For us, management letters are about more than compliance – they’re a tool to help you succeed. If you’d like to learn more, reach out to us today.