For effective corporate governance, it is essential to understand the nuances of Internal Audit vs Financial Audit.
In this post, we explore the key differences between internal and financial audit for organizations to get a clear understanding of each type and their respective roles.
Internal Audit vs Financial Audit: 16 Metrics Compared
Let’s take a look at the difference between internal audit and financial audit based on the following metrics:
Objective:
The main purpose of internal audit assessing a company’s internal controls, operational efficiency, and risk management practices.
Internal auditors thoroughly investigate these processes and suggest improvements wherevery needed.
Financial audit, on the other hand, focuses entirely on ensuring financial statements. They make sure these are accurate, complete, and comply with all legal and accounting standards.
The auditor’s role in a financial audit is to deliver an impartial assessment of whether the financial statements in question accurately reflect the company’s financial standing.
Scope:
Internal audits by nature cover a broad range of areas that may include operational efficiency, risk management, compliance, fraud prevention, and internal controls.
In most cases the scope of an internal audit is set by the management based on areas they feel require strengthening.
Financial audits have a comparatively narrow scope focussing on accuracy and compliance with financial laws.
Auditors conducting financial audits will limit themselves to reviewing financial statements, ledger accounts, trial balance, cash flows, tax compliance, and statutory obligations.
Independence:
Internal audits are conducted by an internal team or an outsourced firm like PKC Management Consulting who have experts across various industries.
Although the internal auditors operate independently, they report to management. They are thus essentially an extension of the team helping organisations build strong processes.
Financial audits are conducted by an external, independent auditors registered with The Institute of Chartered Accountants of India (ICAI).
External auditors maintain complete independence from the company, which ensures that their financial reporting is objective.
Mandatory:
As per Section 138 of the Companies Act, 2013, internal audits are mandatory for certain companies, such as:
- Listed companies
- Unlisted public companies with a turnover of INR 200 crore or more
- Private companies with a turnover of INR2 00 crore or a loan of INR 100 crore or more
Many companies even when not mandatory choose to conduct internal audits on their own for improved governance and risk management.
Financial audits are mandatory for most companies under Section 139 of the Companies Act, 2013 if they meet the prescribed criteria.
- All companies, except very small ones (not meeting the audit threshold), must undergo a statutory financial audit.
- Even small businesses and proprietorships require audits under tax laws (e.g., Tax Audit under Section 44AB of the Income Tax Act, 1961)
Audit Approach:
Internal and financial audits may differ in terms of how they are conducted.
We at PKC have a structured approach which sets our timelines and ensures that we cooperate with the clients to ensure their weaknesses are addressed.
Internal audits are more operational and preventative in focus, while financial audits are more compliance and historical data based.
Methodology:
Internal audits use risk-based auditing. Internal auditors assess business processes, operational risks, and compliance controls by using:
- Conduct process reviews
- Perform data analytics & substantive testing
- Use continuous monitoring techniques
- Provide recommendations for business improvement
Financial audit uses a test-based approach focusing on financial records. It involves:
- Substantive procedures (detailed testing of transactions)
- Analytical reviews (ratio analysis, trend analysis)
- Sampling techniques (checking a portion of transactions instead
Reports to:
Internal audit reports are presented to management, audit committee, or board of directors. The findings help organisations make the right decisions and improve processes.
Financial Audit reports are shared with shareholders, investors, regulatory authorities (MCA, SEBI, RBI, Income Tax Department).
In the case of public companies, the final audit report is a public document.
Information Access:
Both internal and financial audits have access to organisational information but it may differ in scope:
Internal auditors have unrestricted access to all business units, processes, and internal control systems. They evaluate both financial and non-financial aspects.
Financial Auditors, on the other hand, are limited to accessing financial records, accounting systems, tax filings, and bank statements.
They don’t cover operational processes unless they impact financial statements.
Risk Coverage:
Internal audits cover a wider range of risks, including:
- Operational risks (supply chain, HR, IT security)
- Compliance risks (regulatory non-compliance, legal risks)
- Strategic risks (business model failures, market risks)
- Financial risks (fraud, cash flow issues)
Financial audits cover only financial and reporting risks, such as:
- Misstatements in financial records
- Non-compliance with accounting laws
- Errors in tax calculations
- Fraud detection related to financial transactions
Cost Efficiency:
Internal audits are generally more cost-effective. Since they focus on risk prevention, they help to improve efficiency and also ensure that costly errors can be avoided.
Financial audits are more expensive due to the involvement of external auditors, statutory compliance, and regulatory requirements. Plus, non-compliance can lead to penalties.
Audit Findings:
Internal audits identify areas for improvement within a company’s operations, focusing on
- Inefficient processes
- Weaknesses in internal controls
- Potential operational risks
- Governance deficiencies
At PKC, we use structured reports to provide actionable insights into financial, operational, and other key performance indicators.
Financial audits concentrate on the accuracy and compliance of financial reporting, highlighting:
- Errors in financial statements
- Violations of regulatory requirements
- Instances of fraud
- Inaccurate financial data.
Significant misstatements discovered during a financial audit can result in legal repercussions.
Stakeholder Engagement:
Internal Audit engages with internal stakeholders, including:
- Top management (CFO, CEO, risk officers)
- Process owners (department heads, operational managers)
- Audit committee (for listed companies)
Financial audit has to deal with external stakeholders, including:
- Shareholders and investors
- Regulatory bodies (MCA, SEBI, RBI, Income Tax Department)
- Creditors, banks, and rating agencies
Consequences of Non-Compliance:
Weak internal audits risk fraud, operational failures, and financial losses.
Although no direct legal or financial penalties exist, strong internal controls help the management to focus on core business activities.
For financial audits, non-compliance can lead to legal penalties, fines, criminal charges, and loss of investor confidence.
In severe cases, it may result in company closure, revocation of business licenses, and legal action against directors.
Frequency:
Internal audits are conducted periodically (quarterly, half-yearly, or continuously) based on management’s risk assessment.
Some companies have real-time internal audit mechanisms.
Financial audits are generally conducted after the completion of the financial year to assess the annual financial performance.
Flexibility:
Internal audits usually have more flexibility. Their focus and scope can be adjusted based on emerging risks.
Financial audits are closely monitored by external regulatory bodies and thus have more rigid guidelines.
Integration with Business Strategy:
Internal audits can provide insights that influence day-to-day business operations and strategy. Therefore, they have a closer connection with the overall business strategy,
Financial audits, however, mainly focus on accurate financial reporting, and thus have a more limited impact on decision-making.
Frequently Asked Questions
1. What is the main difference between Internal Audit and Financial Audit?
Internal audit focuses on risk management, internal controls, and operational efficiency within a company. Financial audit ensures that the financial statements are accurate and comply with accounting standards.
2. Who conducts Internal Audits and Financial Audits?
Internal audit is conducted by an in-house internal audit team or outsourced professionals, whereas financial audit is conducted by an independent statutory auditor.
3. How often are Internal Audits and Financial Audits conducted?
Internal audits can be conducted quarterly, half-yearly, or as per management’s needs. Financial audits are done annually as per the Companies Act, 2013.
4. Is an Internal Audit as important as a Financial Audit?
Yes! While a financial audit ensures regulatory compliance, an internal audit strengthens risk management and internal controls. Both are essential for a company’s long-term success.
5. Can a financial audit replace an Internal Audit?
Absolutely Not! Financial audits focus only on financial statements, while internal audits cover a broader range of business risks. A company should conduct both to ensure compliance and operational efficiency.
