Home » Accounting » Importance of understanding Business Model in Internal Audit (IA)

Business ModelIn most simple terms Business Model can be defined as the way the organization functions and how it is structured and systems it has put in place to achieve its goals, objectives, mission and vision. The elements of business model include the following

  1. Key product or service.
  2. Pricing strategy.
  3. Manufacturing or value addition process.
  4. Organization design (including hierarchical arrangements and delegation of responsibilities).
  5. Distribution model.
  6. IT systems.
  7. Cost structure.
  8. Flow of communication.
  9. Financing arrangements (including mode of financing, extent of leveraging, working capital aspects)
  10. Sourcing of key resources.
  11. Inventory management system.
  12. People management.
  13. Plans and strategies.
  14. Advertisement and publicity including social media.
  15. Core values.

The above list of elements is only inclusive and work together to enable an organization to function in effective and efficient manner.

The internal audit must understand the every client’s business model – how it generates revenue, extent of automation, key controls and systems put in place, hierarchical design etc. There are numerous business models being followed by different industries and even in same industry different companies follow different model. In certain kinds of industries the business models have evolved at slower pace while in other industries especially those heavily dependent on IT technology there have been disruptive innovations changing the very core of business functioning, rendering many industries and companies redundant.

For instance let us consider retail industry. Earlier revenues were generated from brick and mortar system, then direct marketing and door -door selling was used by some companies. Then came along e-commerce business model and now many organizations have brick and click (both electronic and physical stores) model in place. Again some organizations within the industry rely on heavy discounting, others follow premium pricing model while there are others which sell key products at discount while making profits from complementary but essential products at premium for example razor and blade industry. Again certain retailers rely exclusively on their own brands, others simply indulge in trading in others products, some function as aggregators acting as a medium between the buyers and sellers earning certain percentage of sale price as commission while others give follow a mix of rent and commission model. Similarly there are differences in the other aspects of the industry.

The IA function would not be able to deliver significant value without understanding the key aspects and complexities involved in the ever changing business world and the underlying business model of the client. The proper understanding of these aspects would enable the IA to focus on right areas, ask the right set of questions, properly examine the key underlying assumptions, test the control design and implementation effectiveness, identify weaknesses and leakages. The quality of audit observations and recommendations would be very high.

ca rishabhkumar(The author practices as a Chartered Accountant under the name and style of Rishabh Kumar Barmecha and Associates and is an expert in auditing, financial investigation, direct and indirect taxation. The author can be reached at rishabhkumarbarmecha@gmail.com Mobile No.  91 9007909221 or Twitter @CARKBarmecha.)

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