5 Approaches to Risk-Based Internal Audits

Risk management is an integral part of running a company. There are plenty of factors to take into account, especially when it comes to balancing out risks and the potential rewards.

After all, if you don't take any risks, your chances of raking in high profits are rather slim. On the other hand, risking too much can put your company's future, as well as your own financial well-being, in jeopardy.

This is why you need a capable, experienced group of internal auditors that can provide you with accurate information about your firm's risk capacity, risk appetite, and other risk-related factors.

There are many ways to approach risk assessment, and much of how you get around your RBIA depends on the internal controls that the firm has in place.

Before getting around to carrying out the actual audit, you need to determine the starting point, assess your major risk areas and consider the organizational changes that you're willing to make.

All of this is going to make your auditors' work a lot easier.

Risk-based internal audits (RBIA) are meant to assess whether your company's risk-taking tendencies are sustainable and safe for the future of the enterprise.

Continue reading to learn about the five most common approaches to these types of audits to see which one would be most suitable for your current business model.

Traditional Approach

This approach is very common and generally conducted by professional auditors based on the "checklist" or "decision-tree" methodology.

Through this type of audit, statistical information about the risks associated with particular projects are collected via questionnaires and interviews. Then, a comparison is made between the results and actual performance.

Ultimately, a report is delivered that highlights any discrepancies between predicted and actual risk levels. Because this approach requires using statistical data, it may not be applicable for most smaller firms.

Probabilistic Approach

Another common approach to RBIA is the probabilistic one, which focuses on using mathematical methods to predict and compare probable outcomes from various decisions.

By using a variety of analytical techniques, you can find the probability of the outcomes of the project, including the level of risk associated with it. It can also assess a given project's chances of success or failure at a particular point in time.

This type of approach is generally used by large engineering firms and universities and can be quite complex for small- and medium-sized businesses.

Risk Analysis Approach

Risk analysis is another popular way to conduct an RBIA. Rather than focusing on hypothetical situations and outcomes, this approach utilizes analytical methods and tools to determine the costs of managing the risks associated with each potential outcome.

From there, the approach analyzes the levels of each risk's costs and determines how much it would cost to manage them.

The risk analysis approach can be conducted in a variety of ways, but in general, it rates your company's risks according to both traditional "checklist" audits and the cost-benefit analysis approach. The benefits that each risk offers will depend on its severity.

Risk Appetite Approach

The last common approach to RBIA is the risk appetite approach. This methodology focuses on determining your company's risk appetite and then implementing strategies that will ensure your firm is comfortable with its level of risk.

Companies that use this approach generally develop their risk appetite in four stages: defining your company's objectives, identifying risks, taking steps to cast aside risk, and accepting certain risks in order to realize gains.

RBIA practitioners must not only understand corporate objectives but also know what would define success in each given field. This ensures that all angles are considered when optimizing risk tolerance within the chosen field.

Enlisting an Auditing Company's Services

Along with your business risk attitude, your risk appetite is a causal factor in determining whether your risks are sustainable and can pay off. Unfortunately, most outside auditors are not adequately equipped to conduct comprehensive research into the inner workings of your business.

When it comes to RBIAs specifically, they don't tend to have the right set of skills or methods for conducting the many uncertain parts of these audits.

Instead, you should look into hiring an auditing firm that has experience in risk-based auditing. They will know all the steps to take to ensure that your risks are being managed (or at least, can be managed) correctly.

This will help you stay on track towards your eventual goals without getting off course in a dangerous manner.

What to Consider Before Conducting an RBIA

The method for implementing a risk-based internal audit can vary drastically depending on the auditor, the project team, and the parameters involved.

After all, the only way to successfully mitigate your company's risks is to create a unique risk management plan that fits your business model. No one-size-fits-all approach will work for every firm, so it may be worth your time checking out different risk management software (ERM). It's important to remember that RBIA is ultimately meant to help your company succeed in its endeavors.

By spending more time implementing a risk management plan now, you'll end up saving money later on when you're not suffering severe losses.

Firms looking to implement an RBIA are encouraged to seek assistance from internal auditors at external auditing companies or entrust this responsibility to experienced professionals who have a background in risk management.

The logistics of each method will vary based on the client's needs and the amount of time that can be dedicated to this process.

Using the services of external auditors means that someone else will complete the job for you, which is faster and allows you to focus on running your business. However, it could be costlier than hiring an in-house entity or team that is dedicated to conducting RBIA.

A company's decision about how to conduct an RBIA is dependent on various factors, including its size and the time and energy it would like to devote to this type of project.

If you believe that your company's risk management plan is insufficient for your business model, you should consider all of your options and see if an RBIA would improve your company's chances of success.

The Bottom Line

To sum it up, there are five ways to go about risk-based internal audits: the traditional approach, probabilistic, risk analysis, risk appetite, or going a different route altogether and hiring an auditing firm to implement their own methods to assess your company.

You might want to follow the traditional route because it is the simplest one, but it might not yield the best results if you run a small business.

Look into the probabilistic approach in which data is collected and analyzed systematically and with great accuracy, however overwhelming it might feel.

The risk analysis method can bring a more analytical point of view to the whole process while benchmarking your performance relative to other industries is a great way to identify threats and best practices that you can safely use as your own.

Data from risk appetite keeps nearby threats at a minimum while at the same time increasing your upside for a mutually beneficial result, but you may not want to go for it if you have a large enough business.

If you consider risk-based internal audits to be too much of a hassle, or think that your employees might not carry them out objectively enough, you can also hire an auditing company to handle all of that dirty work for you.

These organizations often charge more for their help, but their auditors usually provide impeccable services, as they understand the intricacies of auditing and are held to the highest standards.

Before contacting one of these firms, though, you might want to look into their backgrounds -- hiring the wrong organization may have disastrous effects on the future of your business.