Internal audit: What it is and why it matters for your business

Published Tuesday 6 January 2026

Table of contents

• What is an internal audit?
• Why are internal audits important for small businesses?
• Components of internal audit
• Types of internal audits
• Key areas of focus in internal audits for small businesses
• Internal audit independence and objectivity
• Key roles in an internal audit
• The internal audit process
• Tips for success when implementing internal audits
• Streamline your audit processes with Xero
• FAQs on internal audits

Key takeaways

• Implement a structured internal audit process with four key phases: planning (including risk assessment), fieldwork execution (document review and staff interviews), comprehensive reporting of findings, and follow-up actions to ensure improvements are actually made.
• Focus internal audits on four critical business areas to maximise impact: financial accuracy through records review, operational efficiency by analysing workflows, fraud prevention by assessing security controls, and risk management evaluation of how you identify and respond to threats.
• Establish proper independence and objectivity by having internal auditors report directly to an audit committee or board of directors rather than just management, ensuring unbiased findings that can drive meaningful business improvements.
• Conduct internal audits at least annually for most small businesses, with quarterly reviews for high-risk areas and monthly checks of key controls for growing companies to maintain effective risk management and compliance.

What is an internal audit?

An internal audit is a systematic examination of your business's operations, finances, and controls to identify risks and improvement opportunities. The key difference is that your own team or hired consultants conduct internal audits, and you use the results inside your business to make decisions.

For example, you may audit risk management strategies to identify how your company can reduce risks. Or, you may audit compliance with an insurer's policy; for instance, cyber insurance policies often have requirements related to firewalls or network access.

Someone outside the company, in contrast, conducts external audits, and the results are for outside stakeholders. For instance, all publicly traded companies must undergo external audits of their financial records every year. Authorised audit companies conduct these audits and release the results to investors.

External audits generally focus on a company's financials, while internal audits tend to focus on operations. But there are definitely exceptions to that rule.

Why are internal audits important for small businesses?

Internal audits help small businesses identify problems before they become costly issues. They provide three key benefits:

• Risk reduction: Spot vulnerabilities in your processes and controls
• Efficiency gains: Find bottlenecks and redundancies that waste time and money
• Compliance assurance: Meet regulatory requirements and insurance policy conditions. For instance, under the Corporations Act, the chief executive officer (CEO) and chief financial officer (CFO) of a listed entity must declare that financial records give a true and fair view of the company's performance, a claim often verified through audits.

Components of internal audit

To make sense of internal audits, it helps to understand their core components. Many auditors use a framework that breaks the process down into five key areas. Thinking about these can help you see how all the pieces of your business work together to manage risk.

• Control environment: This is the foundation. It's about the culture and ethical values you set for your business. It includes your management style and how you structure your team to promote integrity and accountability.
• Risk assessment: This involves identifying and analysing the risks that could stop you from reaching your business goals. It's about looking ahead to see what could go wrong and deciding how to handle it.
• Control activities: These are the specific actions, policies, and procedures you put in place to manage risks. Think of things like requiring approvals for large payments or separating duties so one person doesn't handle a whole financial transaction alone.
• Information and communication: This component is about how you capture and share important information. Clear communication ensures everyone knows their role, responsibilities, and how their work contributes to the business's objectives.
• Monitoring: This is the process of checking that your internal controls are working as they should over time. It can involve regular reviews, spot checks, or ongoing evaluations to make sure everything stays on track.

Types of internal audits

The focus of an audit determines the type of audit. For example, financial audits focus on financial records, while compliance audits focus on a business's compliance with regulations or policies. Here are the different types of internal audits:

• Operational audits that evaluate internal processes to assess efficiency and use of resources
• Compliance audits that check the business follows laws, industry regulations and internal policies
• Financial audits that examine the accuracy of financial reports and the related internal control systems
• Information technology (IT) audits that assess cybersecurity, data protection, network access, technology controls and team training

Key areas of focus in internal audits for small businesses

Internal audits examine how well your business controls work and whether you're meeting compliance requirements. Small businesses typically focus on four key areas:

• Financial accuracy: Reviewing records, data entry processes and access controls
• Operational efficiency: Analysing workflows to find redundancies and bottlenecks
• Fraud prevention: Assessing controls for employee theft and external cyber threats
• Risk management: Evaluating how you identify, monitor and respond to business risks

Internal audit independence and objectivity

You may ask how an internal audit can be objective if the auditors work for the business. Independence is important for a trustworthy audit.

While internal auditors are employees, their role is designed to be impartial. The company’s structure often supports this independence.

In many businesses, the internal audit team reports directly to an audit committee or the board of directors, not just to management. This structure is designed to ensure impartiality, with ASX recommendations for listed entities stating the audit committee should have a majority of whom are independent directors. This allows them to report their findings without fear of pressure or influence.

Objectivity is also a professional mindset. Internal auditors are trained to base their findings on evidence and to remain unbiased in their assessments. Their goal isn't to place blame, but to provide a clear, honest view of the business's operations to help it improve.

Key roles in an internal audit

Internal audit success depends on having the right people in clearly defined roles:

• Internal auditor: Leads the audit process, maintains objectivity, and evaluates findings
• Audit committee: Sets audit priorities, approves plans, and reviews results
• Management: Provides resources and implements recommended improvements

Publicly traded companies or large corporations may have a chief audit executive who reports to the audit committee and the chief executive officer (CEO). In smaller companies, a variety of people may play different roles. For example, a bookkeeper might audit financial reports, while a team manager might audit workflows.

The internal audit process

The internal audit process helps you turn what you learn about your business into practical improvements, in four clear phases:

1. Start planning for your business's internal audit process

Audit planning identifies what to examine and how to examine it effectively.

Start with a risk assessment to identify your biggest vulnerabilities. Then design your audit scope to address these priority risks. This focused approach ensures you're tackling the issues that matter most to your business.

For example, if you're worried about internal fraud, you may need to audit financial statements and money handling processes. But if you're worried about a lack of efficiency, you may need to audit your workflows.

2. Complete the fieldwork/execution stage of the process

The execution phase involves gathering evidence to assess your controls and processes. Common activities include:

• Document review: Examine policies, procedures, and records
• Process analysis: Map workflows and identify inefficiencies
• Staff interviews: Understand how work actually gets done
• Direct observation: Watch processes in action to spot gaps

If you're auditing internal controls, you may need to run tests to assess their effectiveness. For example, if you're auditing your information technology (IT) security, you may need to send fake phishing emails to employees. Then, you can easily spot who needs more training.

3. Start writing a comprehensive audit findings report

Once you're done, write an audit findings report that explains what you discovered and recommends improvements. Then share it with the audit committee or other leaders, such as the owners or managers.

4. Follow up on your internal audit actions

Internal audits should lead to improvements in your business, so follow-up matters. Schedule a time to review any changes you made after the audit. Then, adjust as needed.

Tips for success when implementing internal audits

Successful internal audits require planning and the right mindset. Follow these five essential practices:

• Focus on improvement: See audits as a chance to grow your business, not just a compliance task. They help you identify ways to save money and reduce risk.
• Secure team buy-in: Explain the audit's purpose and benefits. Leadership support is essential for team cooperation.
• Plan thoroughly: Define your scope, set clear goals, and assign responsibilities before you start.
• Make sure you have the right experience: You can hire outside help for internal audits, which is especially important for small businesses. This practice is even codified for some regulated entities; for example, APRA requires that risk management frameworks undergo a comprehensive review by competent persons, which may include external consultants.
• Gather the right data: Whether you're auditing processes or financial records, you need the right data. This may require you to invest in software like process mapping tools to visualise and assess workflows, or accounting software to analyse financial reports.

Streamline your audit processes with Xero

Streamline your internal audits with Xero's comprehensive reporting and real-time financial data access.

Xero simplifies audit preparation by providing:

• instant report generation for any time period or department
• real-time financial tracking to spot issues as they happen
• automated bank reconciliation that reduces manual errors
• detailed audit trails for every transaction

Ready to make your next internal audit easier? Try Xero for free and see how cloud-based accounting can transform your audit process.

FAQs on internal audits

These frequently asked questions address the most common concerns small business owners have about implementing internal audits:

How often should internal audits be conducted?

Most small businesses should conduct internal audits annually. This aligns with standards for regulated industries, as the Australian Prudential Regulation Authority (APRA) requires that a company's risk management framework is reviewed by internal and/or external audit at least annually, with more frequent reviews for high-risk areas.

Frequency guidelines:

• Minimum: Annual process and compliance audits
• High-risk businesses: Quarterly reviews of critical areas
• Growing companies: Monthly checks of key controls

What's the difference between an internal audit and an external audit?

Internal audits tend to focus on process improvement and minimising risks to the business. The results are used internally. External audits tend to be for compliance or financial reasons. The results are shared with external stakeholders: potential investors, lenders, tax agencies, or insurance companies.

What happens if you find issues during an internal audit?

Issues found during an audit show you where there's room for improvement. The issues should be documented in the findings report, shared with leadership, and used to create an action plan.

What are the five components of internal audit?

The five main components are the control environment, risk assessment, control activities, information and communication, and monitoring activities. This framework helps businesses evaluate how effective their internal controls are at managing risks.

What is an example of an internal audit?

A common example is an inventory audit. This type of audit checks that your physical stock count matches the numbers in your accounting records. It helps identify issues like damage, theft or reporting errors, ensuring your financial statements are accurate.