This article throws light upon the two main tools of financial control. The tools are: 1. Financial Audit 2. Financial Ratio.
Tool # 1. Financial Audit:
Another effective control technique is the use of audits, which seek to examine activities or records to verify their accuracy or effectiveness. Financial information is only as good as data and interpretation on which it is based. But figures can lie and liars can figure.
Thus it is absolutely essential to have some form of control to see to it that the data being used in information and control system is accurate. Audits are formal investigations conducted to determine whether records, reports, statements and the data on which they are based are correct and quite in line with the rules and procedures of the organisation.
Audits may be conducted by insiders or outsiders to check on financial and managerial practices.
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External Audit:
Traditionally, auditing has been thought of as an independent appraisal of an organisation’s financial records. It sought to test the validity and the reliability of financial records by determining the degree of accuracy and the extent to which financial statements reflected what they purported to represent.
Thus these programmes are often treated as a way of encouraging honesty on the part of employees and safeguarding the financial resources of the organisation.
This type of auditing, i.e., the verification of financial records, has limited scope for purpose of financial control. Such external audit is usually conducted by certified C.A. firms.
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Outsiders are employed to conduct investigations with a view to guaranteeing objectivity. C.A. firms like S.R. Batliboi & Co., Ferguson & Co. provide trained accounting talent to examine financial records, statements, and procedures for both joint stock companies and others.
The basic objective of choosing an outside auditor is to guarantee to insiders and interested outsiders (e.g., creditors, stock-holders, etc.) that the financial data presented in financial documents give an accurate representation of events and that the audit is conducted in keeping with standard accounting principles and practices.
Internal Audit:
By contrast, auditing can be an effective means of control as well as a means of verifying financial records of a corporation when conducted by a specialised group of company personnel. This process is known as an internal audit.
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Most companies establish regular routines to determine whether people in all positions are doing what they should be doing accurately and efficiently. Internal audits have the advantage of keeping problems in-house and are conducted by people having intimate knowledge of the operations under scrutiny. The internal audit is wider in scope and considers the control system and its performance.
Management Audit:
Auditing techniques may also be applied to determine the overall effectiveness of management. This practice is known as a management audit. This type of audit makes a study of the present and looks to the future. It considers programmes, policies, organisation, operating methods and procedures, financial procedures, personnel practices and physical facilities and reports on the overall effectiveness of the organisation.
The information gathered by a management audit helps upper level executives to ensure that current policies and procedures relate to the overall objectives of the organisation. It highlights major areas demanding attention, improves communication by informing all employees of the state of the organisation, and acts as a test of the effectiveness of the current management control system.
Tool # 2. Financial Ratio or Ratio Analysis (RA):
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A ratio is an expression of the relationships between numbers.
It involves selecting two critical figures from a financial statement and expressing the relationship in terms of a percentage or a pure number. Ratios help accountants and others to measure progress toward goals and assess the financial health of their company’s operations.
If a firm’s balance sheet contains an impressive amount of currant assets it may apparently appear to be a financially sound organisation. But when its current assets are compared with its current liabilities using the liquidity ratio, as defined below, the company may find difficulty in raising enough cash in a short period of time to meet its short-term debts.
Management can better observe relative changes in the performance of the organisation over a period of time by using ratio rather than comparing absolute figures. The use of RA also facilitates comparisons of the performance of different organisations.