# Internal Audit: What It Is, Different Types, and the 5 Cs

![Internal Audit](https://www.investopedia.com/thmb/N6BGPWou_R4QNeutnrDs6s8mzFc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Internal-Audit_Final_4194437-blue-1037a882e56d43d3a48f867cad2c5a6e.jpg)

*— Paige McLaughlin / Investopedia*

> **Definition**
>
> Internal audits are evaluations of a company’s corporate governance and accounting processes.

## What Is an Internal Audit?

An internal audit is an analysis of a business that’s intended to identify opportunities to add value for stakeholders and improve operations. These audits can include processes, procedures, operations, current economic conditions, established controls, company culture, ethics, and product and service quality. They can assess any risks the business faces. The auditors make any recommendations for improvements after the analysis.

### Key Takeaways

*   An internal audit is an examination of a company’s records, systems, processes, and workflows.
*   Internal audits are designed to identify opportunities to make improvements.
*   Internal audits are essential for a business’s success because they’re generally conducted by a [third-party auditing](https://www.investopedia.com/articles/professionals/011116/internal-auditor-job-description-average-salary.asp) service with no interest in the business.
*   A third-party service gives the company objective and unbiased results.

## How an Internal Audit Works

Many types of internal audits are used in various industries. A government agency or a company contracted to do work for a government might be subjected to regular compliance, investigative, and technology audits by law. A private business may hire and schedule an operational audit with a third party to learn ways to become more efficient.

## Types of Internal Audits

There are several types of internal audits:

*   **Compliance audit**: This is a review of a company’s operations and procedures to make sure that internal rules, procedures, and policies are being adhered to.
*   **Financial audit**: Several audits fall under internal [financial](https://www.investopedia.com/terms/f/financial-statements.asp) audits, such as payroll audits, which are used to ensure that employees are paid correctly. Benefit plan audits are used to ensure that the plans offered by an employer comply with legal requirements and are sufficiently funded.
*   **Environmental audit**: These audits assess the environmental performance or the impact that a business’s activities have on the environment.
*   **Technology or IT audit**: These audits assess an organization’s information technology (IT) infrastructure for vulnerabilities and best practices.
*   **Operational audit**: An operational audit assesses an organization’s processes and procedures to identify opportunities for improving operations.
*   **Performance audit**: This type of audit assesses whether a business meets performance [metrics](https://www.investopedia.com/terms/m/metrics.asp) set by management.

## Internal Audit vs. External Audit

The key difference between an internal audit and an external audit is the audience it’s being conducted for.

*   It’s an internal audit if it’s initiated by executives and/or senior management for improvement, even when it’s likely performed by a third party.
*   It’s an external audit if it’s conducted for the benefit of someone outside an organization, such as a forensic audit for legal proceedings. External audits are generally initiated by an entity outside an organization.

## Internal Audit Process

Internal auditing generally follows four steps: planning, auditing, reporting, and monitoring.

### Step 1: Planning

Internal auditors begin by planning how they’re going to conduct the audit. They meet with leadership to determine the goals for the audit, any risks that might be involved, and to work out any logistics and resources that are needed.

Depending on the type of audit, the auditors must become familiar with the [organizational](https://www.investopedia.com/terms/o/organizational-structure.asp) and [financial structures](https://www.investopedia.com/terms/f/financial-structure.asp) of the business they are auditing. Existing controls and procedures and other pertinent information are analyzed, as are previous annual reports. Risks are identified and prioritized. Auditable units within the organization are identified, and information-gathering techniques such as surveys are brainstormed and designed.

The auditors then typically present their plan to leadership/senior management for discussion and feedback. The plan is formalized and presented to an audit committee and the board when this is done.

### Step 2: Auditing

Audits are conducted using the method and checklist that the auditing team developed to assess the business. They may do their best to avoid disrupting work by sending out surveys, assessing available data and workflow graphics, and only moving on to fieldwork when necessary, such as by engaging in physical inventories or employee interviews about processes and procedures.

### Step 3: Reporting

Interim reports are generated with significant findings or even sensitive results when the audit is complete. Auditors might ensure that the company’s board receives the information right away if there are time-sensitive findings, A pre-close meeting can otherwise be held where management can add or provide further information that might alter the findings.

Audit reports typically consist of these elements:

*   Executive summary
*   Objectives
*   Scope
*   Background
*   Conclusion
*   Opinions
*   Management action plan

Executive summaries from the chief audit executive can be used in place of a full-detail report. These summaries describe the scope of the audit, conclusions, significant observations, and any concerns.

The next sections are more detailed than the executive summary. The objectives section outlines why the internal audit was conducted, and the scope defines what areas were included in the audit.

The background section summarizes any information that’s relevant to the activities being audited, and the conclusion is a summary of the outcomes. The internal audit opinion outlines the thoughts of the auditors about the activity under review, and the management action plan is a detailed plan created by management to implement any necessary changes.

### Step 4: Monitoring/Follow-up

Monitoring/following up generally includes smaller-scale audits that might be scheduled with the auditors, to allow leadership to verify that the changes they selected to implement were made. Auditors might look for certain milestones or specific goals that indicate whether any changes were effective or do a more focused analysis of the specific programs or units needing adjustments.

## Internal Audit Reports: The 5 Cs

Internal audit reports often follow what are known as the 5 Cs of reporting. They generally answer these questions:

*   **Criteria**: What needs to be audited and why?
*   **Condition**: What are the observed circumstances surrounding any issues?
*   **Consequence**: How do the issues found affect the company? This might include financial, regulatory, security, publicity, or other effects.
*   **Cause**: What brought attention to the fact that an audit might be required, and what caused the issues that were found?
*   **Corrective Action**: What can the company do to correct any issues?

## Importance of Internal Audits

Internal audits are very important to a business’s [profitability](https://www.investopedia.com/terms/p/profitabilityratios.asp) and overall success. They identify any inefficiencies, and this helps management streamline processes and reduce costs. It allows them to save money to put toward [research and development](https://www.investopedia.com/terms/r/randd.asp), expansionary projects, or [cash or equivalents](https://www.investopedia.com/terms/c/cashandcashequivalents.asp) to pay current debts or even build up a store of emergency cash.

This adds value for stakeholders because they see that the business is working to reduce costs and remain or become profitable, competitive, and relevant in the market.

> **Important**
>
> Investors might notice and share values could increase, benefiting the company and its stakeholders.

Another benefit of internal audits is that they can motivate employees and management to adhere to policies. Knowing that processes and procedures will be analyzed at some point can keep employees on the right path and discourage shortcuts or unethical behavior that might be detrimental to the company.

## The Bottom Line

An internal audit is a review of a business’s processes, systems, and procedures that identifies opportunities for improvement. These audits are generally conducted by third-party entities with no interest in the business, allowing the company to receive unbiased, objective input.  

> **Article Sources**
>
> 1.  The Institute of Internal Auditors. “[Audit Report Writing Toolkit](https://www.theiia.org/globalassets/site/auditing-report-writing-toolkit.pdf).” Page 5.
>     
> 2.  The Institute of Internal Auditors. “[Developing a Risk-Based Internal Audit Plan](https://www.theiia.org/globalassets/documents/content/articles/guidance/practice-guides/developing-a-risk-based-internal-audit-plan/pg-developing-a-risk-based-internal-audit-plan.pdf).” Pages 6–26.
>     
> 3.  The Institute of Internal Auditors. “[Audit Report Writing Toolkit](https://www.theiia.org/globalassets/site/auditing-report-writing-toolkit.pdf).” Page 14.
>     
> 4.  The Institute of Internal Auditors. “[Audit Report Writing Toolkit](https://www.theiia.org/globalassets/site/auditing-report-writing-toolkit.pdf).” Page 4.
>     
> 5.  The Institute of Internal Auditors. “[Audit Report Writing Toolkit](https://www.theiia.org/globalassets/site/auditing-report-writing-toolkit.pdf).” Pages 6–8.
>     
> 6.  The Institute of Internal Auditors. “[Audit Report Writing Toolkit](https://www.theiia.org/globalassets/site/auditing-report-writing-toolkit.pdf).” Pages 8–10.
>     
> 7.  Chartered Institute of Internal Auditors. “[Use of the Five Cs in Communication](https://charterediia.org/content-hub/blogs/use-of-the-five-cs-in-communication/).”