Need and Scope of Management Audit

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on September 3, 2021

Management Audit: Definition

Business management is becoming increasingly complex day by day.

For example, to use specialized techniques such as operational research, statistical sampling, electronic data processing, and production control, the services of experts are required. However, directors are not experts in every field of management.

This has given rise to the need for management consultancy. Management auditors are often called on to advise firms about how to maximize the production of high-quality goods.

Management audits (or consultancies) help to improve the operations of a business. The benefits derived from these services are usually far greater than the costs incurred.

Benefits of Management Audit

The following are some of the benefits of and needs for management audits:

Useful for Performance Appraisal

Management audits enable the appraisal of managerial performance. The standards for every manager are predetermined and their performance is judged based on these standards.

There should be a regular system of evaluation to maintain efficiency standards. Various incentive plans may also be linked with such reports.

Results-oriented

Management audits are results-oriented. Performance is evaluated based on the rates of inputs and outputs. These audits do not assign much importance to the procedures or formalities followed, instead prioritizing performance and results.

Satisfies Financial Institutions

When a business approaches financial institutions to secure loans, the lender is likely to need to evaluate performance. Therefore, if a management audit system is already in place, then lending institutions will not find it difficult to make a decision.

Furthermore, when a company receives management audits, outside agencies will feel reassured that the management is constantly evaluating its performance.

Helpful in Entering Foreign Collaborations

Whenever there is a proposal to enter into a foreign collaboration, then collaborators will not find it difficult to assess managerial potential. They can be provided with a management audit report, enabling them to form an accurate judgment about the organization.

Necessary for Government Organizations

There is an urgent need for management audits in government organizations. The present system of auditing is not useful in reducing inefficiency; it assigns greater importance to formalities and ignores performance.

Management audits, by contrast, emphasize results over following procedures and formalities. Hence, when performance is judged against predetermined standards, officials will be incentivized to improve their efficiency and effectiveness.

Provides a Basis for Critical Evaluation

Management audits are needed for dynamic management because they provide information about important deficiencies and how to overcome them.

Reflection of Organizational Progress

Management audits are useful in knowing the reasonable return on capital employed.

Requirement for Change

The cost audit is very useful for learning about the effect of changes in organizational structure, such as whether a particular change is useful or not.

Helpful in Loan/Advances

Management audits serve as guides to entities that are considering whether to invest in a business or lend it money.

Knowledge of Efficiency and Productivity

Management audits are useful in learning about the efficiency and productivity of any organization. When these indicators are not within the satisfactory limit, suggestions for efficient running can be proposed.

Helpful for Foreign Investors

Management audits are useful to foreign investors because they can understand the profitability of the organization, thereby guiding their decisions regarding investment.

Suitable for Public Sector Units

The study of management audits is very desirable for public sector units. It can improve their working efficiency.

Techniques for Management Audit

Before starting a management audit, the auditor should take special note of the following: aims and objectives of the organization, policies and procedures, planning, communication and its effectiveness, and managerial control devices.

Audit Program

1. The auditor should ensure that the policies are suitable to achieve organizational objectives.
2. The auditor should ensure that all levels of management are following these policies or procedures.
3. The auditor should test the effectiveness of the system of communication.
4. The auditor should also check that all levels of management follow the techniques of management control.
5. The auditor should allocate special attention to the following:

  • Policies with regard to capital expenditure
  • Policies with regard to purchases
  • Policies with regard to selection, recruitment, and training
  • Price policies of commodities and services
  • Effectiveness of research and development
  • Return on capital employed
  • Internal check to control errors and fraud
  • Proper insurance coverage of assets
  • Inventory management, product planning, product control, marketing management, and personnel records

Scope of Management Audit

The primary objective of a management audit is to determine the efficiency of every segment ranging from the lowest to the highest levels of the business. Thus, in a management audit, each and every aspect of the enterprise is examined.

Specifically, the following aspects establish the scope of a management audit:

1. Business Demand: The present organizational structure is reviewed in relation to the current and prospective demands of the business. The study of the organization should be undertaken in relation to the aims and objectives of the enterprise.
2. Return on Capital Employed: It will include the study of present return on investors’ capital. Whether the return is adequate, fair, or poor should be determined by the auditor.
3. Established Relationships to Outsiders: Management audits should also examine the relationship of the business with its shareholders and, more generally, with the investing public.
4. Performance Comparison: The performance of the organization should be compared to other similar firms. Ratios such as operating returns on sales and return on capital should be compared to determine the comparative position of similar organizations.
5. Management Duties: The aims, objectives, and duties of management should also be studied by the auditor. This exercise should be undertaken at the level of the board of directors to keep them within the limit.
6. Financial Planning: Regarding financial planning and control, the efficacy of sources of funds and their use for capital and other expenditures should be evaluated to determine the efficiency in raising and using funds. The cost of each source of capital should be considered.
7. High Right Production and Sale: The review of production and sales functions is important in a management audit. For example, the auditor should check whether production meets the schedule and also whether the sales department is effective.

Regarding the final point mentioned above, the organization’s sales should be quick and efficient, and its distribution channels should be as economical as possible to meet the demand of existing and prospective buyers.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.

Leave a Comment