What Your Financial Audit Isn't Telling You Identifying the Hidden Operational Liabilities

Published on: Sat Apr 03 2021 by Ivar Strand

What Your Financial Audit Isn’t Telling You: Identifying the Hidden Operational Liabilities

The unqualified, or “clean,” opinion from a financial audit is the traditional hallmark of a well-run program. It provides assurance that an organization’s financial statements are accurate and that transactions have complied with established fiduciary rules. This is a critical building block of accountability.

However, this necessary building block is too often mistaken for the entire structure of assurance. A program can be perfectly compliant with accounting standards while simultaneously harboring deep-seated operational liabilities. These are the systemic weaknesses that do not show up as a financial misstatement today but pose a significant threat to the program’s long-term success and the donor’s investment.

The Inherent Blind Spots of a Financial Audit

The scope of a traditional financial audit is, by its design, narrow and retrospective. Its primary function is to attest to the fairness of historical financial information. It is a photograph of the past.

It is not designed to provide an opinion on the quality or efficiency of the underlying processes that generate the financial data. It is not an assessment of the sustainability of the operational model. And it is not a judgment on the robustness of the governance structures that are meant to guide the program. A clean audit opinion can therefore mask a fragile operational reality.

A Typology of Hidden Operational Liabilities

An operational liability is a systemic flaw in a program’s design or execution that creates a high probability of future failure, even if current financial reporting is compliant. In our strategic assurance work, we have found that these liabilities often manifest in several common forms.

1. The Compliant but Crippling Process. A procurement workflow may be fully compliant with every rule, with each of the seventeen required signatures correctly documented. However, if this process is so cumbersome that it takes six months to procure critical medical supplies, it renders the health program ineffective and irrelevant to the needs on the ground. The financial transactions are clean, but the program is failing. The process itself is a liability.

2. Unsustainable Dependencies. A program may successfully meet all its key performance indicators for the year, but do so through a heavy and unacknowledged reliance on a small number of exceptional individuals or on an intensive level of external consulting support. The operational model is not institutionalized and is therefore not sustainable. The positive results are entirely dependent on factors that will disappear the moment a key person leaves or the current funding cycle ends.

3. The “Hollowed-Out” Institution. This is common in environments with low state capacity. A donor-funded project may be implemented through a parallel, ring-fenced project implementation unit (PIU) to ensure tight fiduciary control. The financial reports produced by the PIU may be pristine. However, if this structure actively bypasses and fails to strengthen the relevant government ministry it is meant to support, the program is creating a long-term dependency. This is a significant strategic and reputational liability.

4. Well-Governed Data from Poorly Governed Processes. As we have discussed previously, staff will often use a web of unofficial spreadsheets and informal workarounds to compensate for a dysfunctional formal system. The handful of summary transactions that are eventually entered into the official financial system may be documented and compliant. But the underlying de facto process where the real work happens is uncontrolled, undocumented, and presents a significant unmanaged risk.

From Fiduciary Compliance to Strategic Assurance

To identify these liabilities, donors and senior managers must ask a different set of questions. The inquiry must evolve from “Did the program follow the rules?” to “Is the program’s operational model built for sustainable success?”

This requires a broader mandate for oversight—what we at Abyrint term Strategic Assurance. This approach does not replace the traditional financial audit but integrates its findings into a wider, more qualitative assessment of a program’s operational viability, its governance structures, and its systemic risks.

A clean financial audit tells you that a program was a good steward of funds in the past. A strategic assurance review provides confidence that it is equipped to be an effective and resilient steward in the future. It is the necessary next step in the evolution of due diligence.# What Your Financial Audit Isn’t Telling You: Identifying the Hidden Operational Liabilities

The unqualified, or “clean,” opinion from a financial audit is the traditional hallmark of a well-run program. It provides assurance that an organization’s financial statements are accurate and that transactions have complied with established fiduciary rules. This is a critical building block of accountability.

However, this necessary building block is too often mistaken for the entire structure of assurance. A program can be perfectly compliant with accounting standards while simultaneously harboring deep-seated operational liabilities. These are the systemic weaknesses that do not show up as a financial misstatement today but pose a significant threat to the program’s long-term success and the donor’s investment.