Audited financial statements come with a special bonus: a ‘management letter’ that recommends ways to improve your business. That is free advice from financial pros who have seen hundreds of businesses at their best (and worst) and who know which strategies work (and which do not). If you have not already implemented changes based on last year’s management letter, there is no time like the present to improve your business operations.
Reporting deficiencies
Auditing standards require auditors to communicate in writing about “material weaknesses or significant deficiencies” that are discovered during audit fieldwork.
The American Institute of CPAs defines material weakness 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.” Likewise, a significant deficiency is defined as, “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. Reporting these items is optional, but they are often included in the management letter.
Looking beyond internal controls
Auditors may observe a wide range of issues during audit fieldwork. An obvious example is internal control shortfalls. But other issues covered in a management letter may relate to:
- Cash management
- Operating workflow
- Control of production schedules
- Capacity
- Defects & waste
- Employee benefits
- Safety
- Website management
- Technology improvements
- Energy consumption
Management letters are usually organized by functional area: production, warehouse, sales and marketing, accounting, human resources, shipping/receiving, and so forth. The write-up for each deficiency includes an observation (including a cause, if observed), financial and qualitative impacts, and a recommended course of action.
Striving for continuous improvement
Too often, management letters are filed away with the financial statements, and the same issues are reported in the management letter year after year. But proactive business owners and management recognize the valuable insight contained in these letters and take corrective action soon after they are received. Contact us to help get the ball rolling before the start of next year’s audit.