Training insights – auditing cash flow management

It doesn’t matter how profitable your organisation is if it runs out of cash. “Cash is not king, it’s far more important than that. It’s the oxygen that every organisation needs to survive,” says Raj Gandhi.

Moreover, the current volatile economic environment – inflation, recession, rising interest rates – means that understanding cash flow and the risks and opportunities it creates in your organisation has never been more important. If you have not audited your cash flow management for a few years, you are likely to find that your cash flow situation, your organisation’s needs and, possibly, your risk appetite in this area have all changed significantly.

It is therefore surprising that Gandhi believes this course is unique. “No other course that I have seen offers what this one does,” he says. Furthermore, many internal auditors are unfamiliar with cash flow and have little experience of the current economic challenges. It’s an area that is frequently overlooked or assumed – often erroneously – to be managed well.

Liz Sandwith, chief professional practices adviser at the Chartered IIA, agrees that now is the time for internal auditors in all sectors to revisit cash flow and reassess assurance in this area. She points to the takeaways from a Local Authority Internal Audit Forum event on cash flow management in June last year. Conversations at this event and at the previous one highlighted how many internal audit teams had not recently audited cash flow and did not have it on their agendas.

Many assumed that it was already covered elsewhere, or was more relevant to external audit. “It was clear that we needed to do more in this space,” Sandwith says. “Given the perfect storm of economic stresses that we now face, the number of Section 114 notices already served in local authorities and ongoing liquidity issues and cost constraints, it’s vital that internal audit is looking into how organisations manage their cash – what are their payment terms, where do they do business and what trends do they see among customers and suppliers? All these may have changed significantly since they were last checked,” she warns.

Furthermore, changes to payment terms may have implications that affect other parts of the business – for example, the availability of talent and suppliers, or compliance with the Prompt Payment Code.

Take it to the top

Internal auditors are not the only ones who may have a false sense of security when it comes to cash flow. CEOs and audit committees may assume that it is being managed and that they would be told if there was a problem – particularly if they know that the business is profitable and sales are good.

Internal audit should, therefore, be prepared to push the topic up the agenda and prompt management and audit committee members to ask more searching questions and request regular reports. It’s also important to establish accountability – who is responsible for what and are they actually doing it? Where does the buck stop and who is setting the tone from the top?

One important concern is cash flow forecasts. “The world doesn’t end when the tax year does, so you should ideally be looking at weekly cash flow forecasts for 12 months ahead,” Gandhi explains. “You should also check the accuracy of historical forecasts – if they proved to be wide of the mark, you need to find out why. It could have serious implications for decisions about investment and borrowing.”

Internal audit should report on the quality of assurance over cash flow to the audit committee. Can they rely on what they are told about the organisation’s cash position? “To do this, you need to understand your organisation’s working capital and the terms it offers suppliers and debtors. You need to examine the cash conversion cycle – how long does it take to get the cash – and you need to benchmark your organisation’s practices against others in the sector. Things change,” he says.

Questions to ask

The course aims to explain to those new to the area, and those who have not looked at cash flow for a while, what good cash flow management looks like today. It will encourage attendees to ask more searching questions about the type and quality of scenario testing that their organisation does and the cash flow models it uses (if any).

“You don’t need to be an accountant to understand good cash flow management, you need to know the right questions to ask and whether managers are giving you adequate, reliable answers,” Gandhi adds.

Cash flow management is a core business risk. If it takes too long to turn profits into cash, or your cash is locked away and inaccessible, it could affect everything from the organisation’s ability to carry out basic functions to its ability to invest or make a deal, its reputation and its legal obligations.

“You need a basic understanding of liquidity – how quickly you can get the cash if you need it – and that it is also a business risk to have too much cash, because you are not investing,” Gandhi says. “You need to understand your organisation’s sensitivities to shifts in the market and whether managers are doing adequate stress tests and modelling to identify what different situations would do to your cash flow – are they asking the right ‘what if’ questions?”

Internal audit should be asking how the stated risk appetite relates to the cash flow situation and whether certain scenarios would take the organisation beyond its risk appetite boundaries.

“Too often cash flow has been seen as an add-on to other audits, now it needs to be seen as important in its own right,” Gandhi says. “Internal audit needs to give this risk the time and space necessary to drill down into modelling and forecasting.” He adds that very few of the organisations he sees currently have sufficient oversight, forecasting and modelling in this area.

“I suspect that most internal audits of this area will uncover many things that need to be improved,” he warns. “Ask managers whether their risk appetite relating to cash flow is quantitative or qualitative and I suspect that they won’t have an answer.”

He will discuss examples of high-profile cash flow “disasters” with attendees and will point out that these organisations were not unprofitable, they simply ran out of cash. The aim is to “upskill” internal auditors who are out of practice or who come from non-financial backgrounds by refreshing existing knowledge and exploring new developments and challenges.

“This course will provide a toolkit for anyone planning an audit in this area – and all internal audit teams should be planning one,” he says.

This article was published in January 2023.