The benefits of using a risk assessment matrix in internal audit

What is a risk assessment matrix?

A risk assessment matrix, also known as a risk matrix or risk scoring matrix, is a visual tool used to evaluate and prioritize risks. It plots the likelihood of a risk event occurring against the potential impact of that event. Typically, the risk matrix is a grid, with the x-axis representing the probability (likelihood) of the risk and the y-axis representing the severity (impact) of the risk. Each risk is scored based on these two dimensions, helping to identify which risks require immediate attention and which auditors can monitor over time. A more advanced risk matrix incorporates additional metrics. For example, in addition to impact and likelihood, the risk matrix could include the financial materiality of the risk represented by the size of the dot plotted on the grid. Another option could incorporate time by showing how the risks move across the grid over time based on historical risk scores. With the rapid advances in artificial intelligence, the next step in a risk matrix would be to predict future risk scores and positions on a risk assessment matrix, opening exciting possibilities for the future of risk assessments.

Examples of risk assessment matrices

To further illustrate the practical application of risk assessment matrices, consider the following examples:

3x3 risk assessment matrix

For organizations venturing into the world of risk assessment matrices, a 3x3 risk assessment matrix is a straightforward and powerful tool for visualizing risk variables. The grid uses three levels of likelihood and impact to classify risks, making it a user-friendly option for beginners.

• Likelihood: Low, Medium, High
• Impact: Low, Medium, High

In this risk matrix, risks falling into the "High Impact, High Likelihood" category are prioritized for immediate action, while those in the "Low Impact, Low Likelihood" category may be monitored with less urgency.

To illustrate the benefits, consider if a financial institution implemented a risk assessment matrix to enhance its internal audit function. The institution identified several high-risk areas by systematically evaluating risks across various business units, including cybersecurity threats from shadow IT. The risk matrix helped prioritize audit activities, focusing on these critical risks and ensuring that appropriate controls were in place. As a result, the internal audit team found several examples of technology implementations that did not meet company standards. New methods were enacted to prevent and detect unauthorized applications from being installed on company equipment.

5x5 risk assessment matrix

As you move up in complexity, or for more variability in scoring, a 5x5 risk assessment matrix provides a more granular view of risks, suitable for more complex projects. The 5x5 grid uses five levels of likelihood and impact.

• Likelihood: Rare, Unlikely, Possible, Likely, Almost Certain
• Impact: Insignificant, Minor, Moderate, Major, Catastrophic
  
  
  

This risk matrix allows for more precise risk assessment, enabling organizations to prioritize their risk management efforts better and more accurately. For instance, risks categorized as "Catastrophic Impact, Almost Certain Likelihood" are of utmost priority, demanding immediate and robust mitigation strategies.

Additional risk metrics

Some organizations may add another element to enhance the risk assessment matrix to capture more information, such as varying the size of the plotted point on the grid. In the example below, the point size could represent financial exposure or the materiality of the risk.

1. Financial errors discovered during reconciliation may go uncorrected.
2. Reconciliation reviewers could overlook discrepancies.
3. Third-party vendors could expose the organization to cyber threats.
4. IT systems implemented without company knowledge have security gaps.

For even more flexibility, the third factor in the grid above could also be used as a variable to depict different metrics.

Consider the following example: A manufacturing company may have used a 3x3 risk assessment matrix to manage operational risks. The risk matrix highlighted many high-impact risks, such as supply chain disruptions and equipment failures. To gain better insight, they switched to a 5x5 risk matrix with a materiality variable captured as the size of the plotted point. By visualizing more detail about the risks, the internal audit team developed targeted audit plans and recommended specific control measures to mitigate the identified threats. The company's proactive approach to risk management led to improved operational efficiency, reduced downtime, and enhanced overall performance.

What are the benefits of a risk assessment matrix?

A primary goal of an internal audit function is to provide independent assurance that an organization's risk management, governance, and internal control processes are operating effectively. A risk assessment matrix is vital in this process for several reasons. First, a risk assessment matrix offers a systematic risk identification and evaluation approach. A systematic evaluation ensures the audit team considers all potential risks, reducing the likelihood of overlooking critical risks.

By plotting the relative position of the risks on a visual grid, internal audit can identify the most significant risks and prioritize their activities, focusing on areas that pose the highest threat to the organization. This approach ensures the efficient allocation of the audit's limited resources and maximizes the overall impact of the audit’s efforts. Using a risk assessment matrix allows auditors to include new and emerging risks as they arise and quickly ascertain whether these new threats should lead to an update to the audit plan.

The visual nature of the risk assessment matrix makes it an effective tool for communicating risk information to various stakeholders. It translates complex risk data into a format that is easy to understand, facilitating discussions and decision-making at all levels of the organization. Stakeholders can quickly grasp the severity and likelihood of various risks and prioritize actions accordingly. Some leading audit practices will present multiple risk assessment matrices to management by separating risks by topic. For example, after showing the full risk assessment matrix, they may group all financial risks into one grid and all technical risks in another to facilitate a more detailed conversation with the CFO and CISO, respectively. As many teams move to more frequent or continuous risk assessments, easily digestible data is key to success.

Finally, by aligning the risk assessment with organizational goals, the matrix helps ensure that audit activities support achieving strategic objectives. The risk assessment matrix serves as a clear visual communication tool to highlight the most urgent risks the organization needs to face to achieve those goals. A risk assessment matrix also contributes to the collaboration between internal audit and other assurance providers like risk management teams who are working toward the same goals. The easy-to-read format of risks plotted on a grid provides a universal format for interpreting the group's understanding of any given risk. To ensure the teams speak a common language, internal audit and risk management should align on the terminology related to risks and the scoring method used. If internal audit uses a 3-point scale (3x3 matrix) and risk management uses a 5-point scale (5x5 matrix), the teams will have difficulty communicating effectively when comparing risk scores.

How to implement a risk assessment matrix in internal audit?

Implementing a risk assessment matrix in internal audit involves several key steps:

1. Identify risks

The first step is to identify potential risks that could impact the organization. This involves gathering information from various sources, including risk registers, previous audit reports, and input from key stakeholders. It is essential to consider both internal and external risks, encompassing operational, financial, strategic, and compliance-related threats.

2. Assess likelihood and impact

Once risks are identified, the next step is to evaluate their likelihood and impact. This assessment can be based on historical data, expert judgment, and other relevant information. Likelihood refers to the probability of the risk event occurring, while impact measures the potential consequences if the event does occur. Both dimensions are typically rated on a scale, such as low, medium, and high for a 3x3 matrix, or more detailed levels for a 5x5 matrix.

3. Plot risks on the matrix

After assessing each risk's inherent likelihood and impact, plot them on the risk assessment matrix. This visual representation provides a clear overview of the risk landscape, highlighting which risks fall into high, medium, and low categories. Risks in the upper right quadrant (high likelihood, high impact) are the most critical and require immediate attention. Once the audit is complete, consider going through this exercise again for residual risk scores. During the next risk assessment round, or when using a continuous or rolling risk assessment, you can leverage the insights gained from a residual risk score and update your risk assessment accordingly.

4. Prioritize audit activities

Use the matrix to prioritize audit activities, focusing on high-risk areas first. This prioritization ensures that audit resources are directed toward the most significant threats, enhancing the efficiency and effectiveness of the internal audit function. Medium and low-risk areas can be monitored and addressed based on available resources and emerging risk trends.

5. Communicate findings

Share the risk assessment matrix with relevant stakeholders, including senior management, the audit committee, and the board of directors. This communication helps build a shared understanding of the organization's risk profile and supports informed decision-making. It also enhances transparency and accountability in the risk management process.

6. Review and update regularly

The risk environment is dynamic, with new risks emerging and existing risks evolving over time. Regularly review and update the risk assessment matrix to remain accurate and relevant. This ongoing assessment supports continuous improvement in risk management practices and helps internal auditors manage emerging threats.

Conclusion

In conclusion, a risk assessment matrix is a powerful tool that offers numerous benefits to the internal audit function. It provides a systematic and structured approach to risk identification, evaluation, and prioritization, enhancing risk awareness and understanding. The matrix strengthens governance, compliance, and overall risk management practices by facilitating efficient resource allocation and supporting informed decision-making. Implementing a risk assessment matrix in internal audit fosters a culture of continuous improvement and proactive risk management, ultimately contributing to the organization's success and resilience in a dynamic business environment.