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Use management letters to improve your business

Take a few minutes to review the management letter.  It generally contains advice on ways to make your business more efficient, more profitable – and less risky.

What’s required?

Auditing standards require auditors to communicate in writing about “material weaknesses or significant deficiencies” that are discovered during audit fieldwork.

Material weakness. The AICPA defines this 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.”

Significant deficiency. This is generally considered less severe than a material weakness. It’s 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 weaknesses and operating inefficiencies during the course of an audit.  Although reporting these items is optional, they’re often included in the management letter, or they may be reported to management verbally.

Responses to management letters vary

Audit clients differ in their response to management letters and verbal suggestions. Some ignore the advice, thinking it’s just a way for the auditor to up-sell consulting services. Others take offense, perceiving that the auditor is “grading” management’s performance.  But conscientious clients pay attention — and often reap substantial benefits.

Consider the manufacturer who embraced his auditor’s recommendation to take advantage of early-bird discounts offered by suppliers. Last year’s management letter pointed out that early-bird discounts could have saved the client $45,000 in the first quarter, based on the auditor’s review of cash disbursements.

Instead of filing invoices by due date, the company’s payables clerk now files them by discount date and pays them early when extra cash is on hand. The owner estimates this simple change saved the company roughly $100,000 in 2016.

Observant auditors may comment on a wide range of issues they encounter during the course of an audit.  Beyond internal controls, auditors may provide noteworthy comments regarding cash management, operating workflow, control of production schedules, capacity issues, defects and waste, employee benefits, safety, website management, technology improvements and energy consumption.

A valuable add-on

Auditors see clients at their best and worst. They know problems that other manufacturers have experienced and how they solved them (or not). Why not take advantage of the industry knowledge and objectivity that your audit team brings to the table?  You might very well discover that the management letter is the most valuable part of the audit process.

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