Recession Clouds Are Forming – What Should Internal Audit Do To Get Ready?

Over the past couple of months, fears of a looming recession have percolated around the world, with politicians and pundits in the United States debating whether one’s already underway in the U.S. (defined as two consecutive quarters of negative GDP growth). Regardless of if or when we officially enter a recession, one thing is certain: A “recession watch” is already impacting internal audit.   

I went into a recent CAE roundtable fully expecting more conversation about internal audit resource growth, shifting audit priorities, and the festering talent shortage. Instead, CAEs talked about budget cuts, hiring freezes and audit priorities that are shifting to address recessionary risks. These weren’t isolated concerns. CAEs from multiple industries were sharing the same stories.

So, what can internal auditors expect if/when a recession really materializes? Having experienced at least seven recessions during my career, I know that economic downturns offer both threats and opportunities for internal audit. Organizations facing severe pressures on the bottom line often disproportionately – and foolishly – penalize internal audit when making budget and staffing reductions. For example, in 2009, amid the Great Recession, 35% of Fortune 500 internal audit departments lost staff. In a blog post leading up to the COVID economic downturn in early 2020, I urged internal auditors then to clearly demonstrate and articulate their value to their organizations before the next recession.

There is no question in my mind that the CAEs in the recent roundtable are at the top of their game in demonstrating and articulating value. Yet, they are already feeling the headwinds of a looming economic downturn. Unfortunately, I suspect those headwinds will reach gale force for the most vulnerable internal audit departments.

As past recessions approached, I strongly urged internal audit to turn its attention to demonstrating how it could help organizations navigate the looming economic downturn. As a profession, we are duty-bound to follow the risks. When pressure on the bottom line (and, potentially, even the survivability of the organization) becomes a primary risk, we need to roll up our sleeves and get to work.

In 2009, the world was experiencing the depths of the worst financial crisis in 70 years, and internal auditors were focused on identifying cost reductions, as well. I recently looked back at an IIA survey from that time to gain some perspective on where the most success was found. These were the five areas:

• Vendor payments.
• Contract compliance/administration.
• Organization control structure/span of control.
• Construction and capital projects.
• Revenue assurance.

However, before you launch an extensive effort into any of those areas, make sure you are prepared to do it right. A Harvard Business Review article published during the Great Recession offered some timeless advice on corporate cost-cutting, including these two astute observations:

“First, forget about finding a single idea that would radically change the cost structure of your organization or department, thereby solving your problem in one go. (If such an idea existed, it would most likely entail so much risk that the organization would never be willing to implement it.) Instead, you should plan to reach your goal with a combination of 10 or more actions.”

“Second, the degree of organizational disruption caused by your reductions will usually be proportional to the degree of cutting you do.”

The authors of that article also provided these specific ideas to achieve the easiest 10% reduction in costs:

• Take overdue personnel actions.
• Reduce spending on department management.
• Gain control of “miscellaneous” spending.
• Hold down pay increases.
• Re-propose rejected cost-saving ideas.

None of those concepts are radical or new, but they can be very powerful when implemented quickly. Keep in mind, today’s level of inflation was not a factor when that advice was being offered.  

It is important to recognize that many cost-saving actions can impact future risks. Cuts in the wrong place can subject an organization to unacceptable risks in the future. There needs to be a balance between what’s needed now and effective risk management going forward (e.g., sufficient internal controls over contracts and vendors). 

The purpose of this blog post is not to be doom and gloom, but to shine a light on how quickly a “recession watch” is emerging and to spur internal auditors to take steps now in anticipation of an emerging imperative to reduce costs. I encourage you to immediately start a dialogue with management and the audit committee about the risks that a recession may bring. And approach the conversation with specific ideas for how internal audit can help.

We face extraordinary challenges. To be sure, internal audit will be tested once again to prove its value by identifying and responding to risks brought on by economic turmoil in a way that supports the organization best. This is not a short-term “project” for internal audit. Indeed, the related risks will likely continue well into next year and evolve dramatically. Internal audit must continue to be agile, adaptive, and responsive. Our organizations deserve nothing less.

I welcome your ideas on ways internal audit can help organizations stand strong against today’s and tomorrow’s economic headwinds.