The pandemic has confronted many managers with the need to consider some belt tightening.
Indeed, many organizations have been forced to delay capital investments, reduce inventory levels, furlough and lay off workers, and conduct other cost-cutting activities over the last months, as they worked to make ends meet. Internal audit has a role to play in how companies conduct such measures. Several of my recent internal audit assignments, for example, have been related to the effective management of operating expenses.
Over the last few months, managers and audit committees have been asking assurance on their cost management practices. The scope of work on the subject is wide and includes benchmarking cost structure across entities, reviewing the existence of adequate policies and dashboards, identifying quick wins for cost reduction, reviewing bidding and supplier selection procedures, and—on a more tactical level—the analysis and recovery of overdue payments.
With a few exceptions, such as those companies that apply a strict Zero-based budgeting discipline, most cost management initiatives are conducted as “one-off” actions with no structural mechanism in place to prevent expenses ballooning again once the effects of the pandemic subside. In essence, cost management remains tactical and not a core component of most companies’ operating model. While COVID-19 has been a catalyst of serious cost-control initiatives, management frequently lacks a clear view of how and where they spend money.
While seeking cost savings is not internal audit’s primary role, auditors are well-positioned to evaluate the governance and controls in place to monitor and keep expenses under control. Specifically, auditors should verify that cost management is supported by three fundamental enablers: spend transparency, procurement collaboration, and monitoring.
Spend Transparency
First, internal auditors should verify that line managers obtain the right data to manage costs. Often, companies rely on cost center reports comparing actual against budgeted costs. However, effective management of costs calls for a more detailed analysis, such as spend per vendor, total number of vendors for similar goods and services, and trend analysis. Simply tracking profit and loss categories and budget variances is not effective for managing costs at the right level of detail. The control environment must enable a deep examination of the cost structure, its drivers, and the use of the supplier base.
As a first step, auditors should verify that costs are recorded consistently and in the right category. Through recent projects, I have observed numerous cases where similar costs were recorded in different general ledger accounts across business units and regions. Second, auditors should look to see that front line managers are provided with data and analysis enabling them to answer questions such as:
- What is the total spend to each vendor, by region, item, and business unit?
- Are there identical items procured from different vendors and at different prices?
- Are all available discounts captured from vendors?
- Are contract terms complied with?
The ability to answer these questions is critical for managers who aim to identify spend leakages, un-controlled expenses, price discrepancies, and purchasing patterns across the organization.
Procurement Collaboration
Second, internal auditors should go beyond the mere adherence to purchasing practices and evaluate the influence and performance of the procurement team. Proper bidding and effective contracts do not guarantee that procurement is fully contributing to cost optimization. Organizations, with the help of internal audit, must look at the broader picture and assess the impact and engagement of procurement in actively managing costs.
Most procurement organizations have processes and controls related to price negotiation and vendor selection; the objective being price reductions for what the company is currently purchasing. However, effective cost management entails a long term strategy of optimizing requirements, prices and operational control. Audit should assess the role of procurement in shaping and influencing the initial requirements. Auditors should appraise whether procurement is working with:
- cost center managers to put the spotlight on unnecessary spend and challenging them
- project engineers during the scoping phase to ensure that capital investments are not over-spec and that budgets are properly calculated and sized
- supply chain planners to align and optimize buying decisions with the production requirements
- lawyers, to ensure that commercial terms are optimized and include penalty/reward clauses that directly tie with supplier performance
- finance managers to define operating and capital budget considering spend reduction opportunities
Such procurement capabilities create tangible value for cost management as they push companies to buy what’s really required for the organization.
Monitoring
Third, auditors should ensure that a monitoring system is in place to measure the effectiveness of cost management and procurement programs. The key is to prevent managers from reverting to old spending patterns. Standards methods for calculating and measuring cost savings must also be established. Recent audit engagements reveal a wide range of conflicting definitions within and across companies. In addition, internal audit must evaluate the process to assign ownership, set deadlines, define targets, and follow-up on cost drivers and the outcome of improvement initiatives.
The absence of spend data, a weak inclusion of the procurement function, and a lack of focus on cost drivers are barriers to effective cost management. By appraising the status of these components, internal audit can provide valuable assurance on cost management and strengthen a company’s performance. 
Jean-Marie Bequevort is Expert Practice Leader Internal Audit at TriFinance, a consulting company with offices in Belgium, Luxembourg, Netherlands, and Germany.