Outside the box: preparing for recession risks
Many managers – including internal audit leaders and those in the wider business – have never held senior decision-making positions in a period of recession. We have operated for more than ten years in an economic environment of historically low interest rates and relatively low consumer goods prices. All this has now changed. The UK (unlike Ireland) will probably experience negative growth, even if it narrowly avoids a full recession.
Soaring energy prices and a shortage of food ingredients caused by the war in Ukraine and by climate extremes have sent inflation into double figures. Interest rates have been ramped up accordingly, putting pressure on borrowers. While the headline rates of inflation are almost certain to fall this year (unless the war in Ukraine escalates), this is partly because inflation is measured against prices 12 months previously – meaning that it will now be judged against prices that had already risen dramatically after the outbreak of war. A drop in inflation will not mean lower prices, so consumers, employees and employers alike will continue to feel the squeeze on their spending power.
For organisations in sectors that are still feeling the effects of the pandemic – from changing consumer habits and talent shortages to repaying government Covid loans – a potential recession has come at the worst time possible. For those that emerged relatively unscathed from the pandemic, it is creating a new range of risks that need monitoring and mitigating.
Former president and CEO of IIA Global, Richard Chambers, was warning chief audit executives (CAEs) to prepare for an economic downturn in a blog post last September and expressing concerns that too many organisations cut back on internal audit just when they should be ramping it up. He advised CAEs to start analysing the risks associated with cost-cutting across the organisation and to think broadly about the cumulative effects of multiple actions.
It may be time to look afresh at financial risks. While financial audits have never gone away (particularly during the Covid pandemic), many internal audit functions now view financial risks as business as usual – they need strong controls and robust processes, but do not need regular attention from internal audit, which can rely on second line assurance and focus on new and emerging issues.
Current circumstances mean that financial risk and assurance – from cashflow to investment decisions – is now back on the agenda. Furthermore, associated risks such as employee and customer fraud, staff satisfaction and wellbeing concerns and third-party dangers should also be under internal audit scrutiny. It’s important to keep up to date with financial trends and developments that could potentially affect not only your organisation’s finances, but also those of your customers, suppliers and staff.
Even if you have experience in internal audit in previous recessions, the world has moved on since 2008-09. Cybercrime and global IT and supplier networks are areas where there have been obvious developments, but staff expectations (and opportunities) have also changed. Individuals are both more exposed to high interest rates (mortgage loans are far larger than in previous eras) and more likely to be connected to the organisation’s central IT systems and to be working from home.
In addition to keeping up with the financial news, internal audit should be asking how well the company knows its staff and senior management (what is its culture?), and how well they understand their suppliers’ and customers’ businesses. How soon would they know if a third-party was in financial difficulties and do they have plans in place to deal with a collapse?
Recent news stories have highlighted the wide-ranging nature of the risks associated with managing in a recession:
• Research in January by insolvency firm Begbies Traynor showed that the number of UK businesses in “critical financial distress” rose by over a third in the last three months of 2022 as they came under pressures including rising energy prices and reduced consumer spending and had to repay Covid loans.
• NatWest highlighted very low levels of borrowing to fund investment, which it warned could impact future growth.
• There have been multiple impacts on staff – particularly those on lower pay. Ambulance crews in Scotland warned the BBC in January that they are attending higher numbers of calls for people who are ill because they cannot afford to heat their homes.
• Strikes have become ubiquitous in the public and private sector – Amazon staff recently joined rail workers, Post Office employees and numerous categories of public-sector workers who are protesting.
Silver linings
However, every cloud has a silver lining and it’s also important that boards have the information to take advantage of opportunities in changing circumstances, while remaining appraised of the risks. Internal audit can play an important role in helping to keep management informed of rapidly changing risks, offering assurance the board can trust on the organisation’s finances and critical risks so managers base decisions on sound data, but don’t become swamped in unnecessary detail. They can help to maintain executive focus on the organisation’s stated risk appetite and question whether this is still appropriate.
It’s helpful to keep an eye on what others are doing – and not just in your own region. For example, according to a survey of more than 500 senior financial decision-makers in the US, UK, Germany and Singapore by “working capital solutions provider” Taulia, businesses in Singapore and the US are more likely to invest in technology and infrastructure than to cut costs by seeking cheaper suppliers and reducing staff expenses. US decision-makers said they are prioritising investment in automation and then supply chain management tech, while their peers in Singapore were investing first in supply chain management tech and second in automation.
Reducing waste is another area that may provide opportunities and help organisations to meet emerging and future environmental targets. High energy costs are prompting organisations to look at turning thermostats down and switching off lights. An investment in automation now may pay back sooner than it would have done a year ago if it enables an organisation to reduce energy consumption or offer better customer service and value.
Internal audit teams that can utilise data analytics and compile rapid updates automatically on critical risks will have an advantage, so if you don’t have these capabilities this may be a good time to make your case for investment. Check what other internal audit functions in your sector are doing and what more you could offer with better data at your fingertips.
So far, unemployment has not risen significantly and talent remains in short supply, so staff who are feeling the pinch elsewhere may be happy to consider moving to employers who seem more supportive. This may not always mean those that offer a better pay packet.
Not all organisations can make capital investments in tech or staff in an economic slowdown, but internal audit must be thinking about every way it can add value at a difficult time. A well-informed internal auditor who understands the pressures faced by management and
can talk constructively about opportunities as well as risks is more likely to be treated as a “trusted adviser”. Financial pressures will be felt by all functions and an internal audit team that is not offering valued support may instead feel the direct effect of budget cuts on its own operations.
This article was published in March 2023.