Internal audit: what it is and how the process works

Published Thursday 2 April 2026

Table of contents

• What is an internal audit?
• Why are internal audits important for small businesses?
• Types of internal audits
• Key areas of focus in internal audits for small businesses
• Key roles in an internal audit
• Internal audit process stages and how to conduct your own
• Tips for success when implementing internal audits
• Streamline your audit processes with Xero
• FAQs on internal audits

Key takeaways

• Conduct internal audits at least once a year to identify risks, improve efficiency, and ensure compliance with insurance policies and industry regulations before problems become costly.
• Focus your audit on the four main types based on your business needs: operational audits for workflow efficiency, compliance audits for regulatory requirements, financial audits for record accuracy, and IT audits for cybersecurity measures.
• Plan thoroughly by assessing your biggest business risks first, then design your audit to target those specific areas rather than conducting a general review.
• Follow up on audit findings by scheduling regular reviews to ensure you implement recommended changes and measure whether those improvements are working as expected.

Key takeaways

• Internal audits examine your processes, finances, and systems to identify risks and improve efficiency
• Audit results stay within your company and help you make better business decisions
• Some insurance policies and industry standards require regular internal audits
• You can conduct audits yourself or hire outside consultants for specialised expertise
• The four main types are operational, compliance, financial, and IT audits

What is an internal audit?

An internal audit is an independent review of your business's finances, processes, and systems to identify risks and find areas to improve. At its core, auditing is critical, investigative, and focused on reviewing and verifying your measurements and communications. The results stay within your company and help you make better decisions.

Auditors often work for the company, but you can also bring in outside consultants. Either way, the findings are used internally rather than shared with external stakeholders.

For example, you might audit risk management strategies to reduce threats. Or you might check compliance with an insurer's policy, such as cyber insurance requirements for firewalls or network access.

How internal audits differ from external audits:

• Internal audits: Conducted by employees or hired consultants; results stay within the company; typically focus on operations and processes
• External audits: Conducted by independent audit firms; results go to outside stakeholders like investors or regulators; typically focus on financial statements

If your company is publicly traded, you must undergo external audits of your financial records every year, typically working with one of the "Big 4" audit firms like PwC, Deloitte, KPMG, or Ernst & Young. Small businesses usually only need internal audits unless lenders or insurers require otherwise.

Why are internal audits important for small businesses?

Internal audits give you a chance to step back and examine your processes before problems become costly.

Here's what internal audits can do for your small business:

• Improve efficiency: Identify bottlenecks and redundancies in your workflows
• Reduce risks: Spot vulnerabilities before they lead to fraud or financial loss
• Ensure compliance: Verify you're meeting insurance policy requirements and financial regulations
• Support better decisions: Provide data and insights to guide business improvements

For example, an internal audit might review your fraud prevention controls. Auditors compare your documented processes to actual workflows, identify gaps, and recommend improvements you can act on.

Types of internal audits

The four main types of internal audits are operational, compliance, financial, and IT audits. The type you need depends on what you want to examine.

• Operational audits: Evaluate internal processes to assess efficiency and resource use
• Compliance audits: Verify that your business follows laws, industry regulations, and internal policies
• Financial audits: Examine the accuracy of financial reports and the effectiveness of internal controls
• IT audits: Assess cybersecurity measures, data protection, network access, and team training

Most small businesses start with operational or financial audits, then add compliance or IT audits as they grow.

Key areas of focus in internal audits for small businesses

Internal audits examine your internal controls, regulatory compliance, and financial accuracy. Here are the key areas to focus on:

• Financial records: Review the accuracy of your numbers, data entry processes, access controls, and who's responsible for reporting
• Operational processes: Assess workflow steps, task ownership, and opportunities to reduce redundancies or inefficiencies
• Preventing fraud: Evaluate controls against internal fraud (employee theft) and external threats like phishing or cyberattacks
• Managing risk: Identify your biggest risks and assess how well your business can respond to a crisis

Key roles in an internal audit

Internal audits involve three key roles, though in small businesses one person may handle multiple responsibilities.

• Internal auditor: Leads the process, evaluates records or processes, and maintains objectivity throughout
• Audit committee: Identifies audit scope, approves the audit plan, and reviews the findings report
• Management: Allocates staff and resources, then implements the audit recommendations

In larger companies, a chief audit executive reports to both the audit committee and chief executive officer (CEO). In smaller businesses, roles often overlap. For example, your bookkeeper might audit financial reports while a team manager audits workflows.

Internal audit process stages and how to conduct your own

Here's an overview of the internal audit process:

1. Plan for your business's internal audit process

Plan thoroughly to set up your entire audit for success. Start by identifying what you want to examine and how you'll conduct the review.

Begin by assessing risk to identify your most significant business risks. Then design an audit that targets those specific areas.

For example, if you're concerned about internal fraud, audit your financial statements and money handling processes. If efficiency is the issue, focus on workflow audits instead.

2. Complete the fieldwork/execution stage of the process

During fieldwork, you gather evidence and test your processes. In this phase, you review hands-on how your business actually operates.

Your audit procedures might include:

• Reviewing documents and financial records
• Analysing processes against documented procedures
• Interviewing employees and managers about their roles
• Observing workflows in action

If you're auditing internal controls, run tests to check their effectiveness. For example, an IT security audit might include sending fake phishing emails to see which employees need more training.

3. Write a comprehensive audit report

Your report documents what you found and what to do about it. Summarise the audit scope, what you found, risks you identified, and specific ways to improve.

Share the report with your audit committee or relevant leadership, such as owners or managers. Make sure what you recommend is clear and actionable so the team can implement changes.

4. Follow up on implementing the internal audit

Following up turns what you found into real ways to improve. Following up ensures your audit delivers real value.

Schedule time to review whether you implemented the recommended changes. Check if those changes are working as expected, and adjust your approach if needed. This step completes the process and ensures your audit delivers measurable results.

Tips for success when implementing internal audits

Follow these tips to run a successful internal audit:

• Focus on the benefits: Treat the audit as an opportunity to improve your business beyond meeting compliance requirements
• Build team support: Ensure everyone understands the purpose and value of the audit, starting with management support
• Plan in advance: Define the scope, set clear goals, and outline who handles each part of the process
• Bring in the right expertise: Hire outside help when you need more audit experience, especially for specialised areas like IT or compliance
• Gather the right data: Use accounting software or process mapping tools to collect accurate information before you start

Streamline your audit processes with Xero

Xero helps you streamline internal audits by making the numbers you need easy to access. Generate accurate reports, track financials by project or department, and analyse data in real time.

When you can clearly see your finances, you can complete audits faster and decide confidently based on reliable data. Get one month free and see how Xero simplifies your audit process.

FAQs on internal audits

Here are answers to common questions about internal audits:

How often should internal audits be conducted?

Most small businesses should conduct internal audits at least once a year. If you're managing higher risks, consider a mixed schedule where high-risk functions like IT security and compliance are audited every quarter or six months, while lower-risk areas are reviewed every two or three years.

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

• Internal audits: Focus on improving processes and reducing risk; results stay within your company
• External audits: Focus on financial compliance; results go to investors, lenders, tax agencies, or insurers

What happens if you find issues during an internal audit?

Document issues in your findings report, share them with leadership, and plan how to act on them. Audit findings show you where to improve, so treat them as opportunities for growth.

Can I conduct an internal audit myself, or do I need to hire someone?

If you have the time and knowledge, you can conduct basic internal audits yourself. For specialised areas like IT security or complex compliance rules, consider hiring an external consultant who can stay objective and bring expertise.

How much does an internal audit cost for a small business?

Costs vary based on scope and who conducts the audit. DIY audits cost mainly your time, while hiring an external consultant typically ranges from $1,000–$5,000 for a basic review. Complex audits covering IT or compliance may cost more.