Return to core competencies: How audit committees can help navigate a new world

As Canadian CEOs and business leaders continue to navigate the economic volatility from the past several years, their outlook has tempered with renewed focused on tackling the challenges and hurdles ahead with a steadfast level of confidence in their organization’s growth prospects. Still, they must navigate ongoing geopolitical risks and other disruptions that are challenging their organization from becoming more sustainably agile and resilient.

While the responsibilities of audit committees have expanded greatly in recent years to include oversight of such things as environmental, social and governance (ESG) reporting, talent, cybersecurity and artificial intelligence (AI), it is their core competencies and roles that will often be called upon to help organizations capitalize on new opportunities and recover from difficult times. Perhaps not surprisingly, these leaders say they feel under more pressure to ensure the long-term prosperity of their business, according to our latest annual Global CEO Outlook.

After the disruption of the past several years, the global economy is getting healthier and there is more clarity on the direction of policy interest rates. Supply chains are functioning normally, global inflation is cooling, and many major central banks have begun rate-easing cycles or have signaled an intent to do so.

The U.S. Federal Reserve is among those banks, and since U.S. consumer spending has been the engine of North American growth, lower rates are likely to help fuel continued economic growth on the continent. U.S. employment numbers are also strong; it appears the U.S. has evaded a recession and engineered a soft landing for its economy—possibly leading other jurisdictions along this trajectory.

The Bank of Canada has also been lowering rates, and this may prove to be even more beneficial in ensuring economic growth in the country. Canada has the highest consumer debt level in the G7, but most debt is in the form of five-year fixed-rate mortgages that have so far insulated many borrowers from the highest rates.¹ With many of these set to be renewed, lower rates—in addition to the usual growth benefits of lower borrowing costs—will help prevent materially higher monthly payments for many existing borrowers and the resulting reduction in consumer spending that might occur.

These potential effects serve as a reminder that audit committees need to ensure management is relying on sound economic analysis for forecasting and estimates and engaging outside experts where needed. For instance, beyond the direct impact of interest rates on the organization, it’s crucial to develop reasonable estimates of the effects of interest rates on consumer spending and the resultant demand for the organization’s products and services.

Appearing to belie the rosier economic outlook, there’s been a substantial uptick in Canadian business insolvencies.² However, we don’t think this reflects a progressive weakness in Canadian corporate health. Instead, it reflects a delayed reckoning for weaker businesses.

During the early days of the pandemic, the government provided many organizations with various forms of assistance, which helped some weaker businesses survive longer than they might have otherwise. Now, with the assistance gone, requirements for repayment and an increase in the cost of debt, we’re seeing delayed bankruptcies occurring with these weaker organizations. Audit committees at struggling organizations will need to ensure they are continuously communicating with management and, if necessary, may need to take a leadership role in the discussion as to whether the organization remains a going concern.

Even some stronger firms have struggled in recent years, but Canadian banks have been patient. Viewing this as a temporary situation, they’ve worked with these organizations and in many cases have extended covenant relief rather than forcing them into bankruptcy—underscoring the value of proactively working with your bankers to weather difficult times. Audit committees should ensure management is regularly communicating with their banks and that they fully understand the organization’s debt covenants and where it stands in terms of satisfying them.

Meanwhile, the strongest corporations have joined venture capital and private equity in amassing record amounts of cash. With the improved economic environment lower borrowing costs, this may lead to a surge of M&A activity and capital projects in early 2025. Audit committees will want to ensure management is keeping them apprised of planned M&A initiatives so that the committee can oversee assessing the integrity of the target’s financial reporting and controls and help guide the integration of the finance functions resulting from a transaction.

Although economic risk has declined, geopolitical risk remains historically high. This year has also been a notable year for global elections with many voters around the world looking for change, which may lead to long-term implications as the power dynamics of global leadership can create uncertainty around future economic, trade and security decisions.

Audit committees will want to question management on how they’re tracking geopolitical risks and their potential effects on the organization. The complexity of these issues and their economic and business implications mean internal expertise may not always be sufficient for this analysis, so management and the audit committee may want to consider engaging outside experts where necessary.

Geopolitical events have forced organizations to revisit how they assess risk. It’s impossible to account for low-probability, high-impact risks using traditional financial forecasting, so leading organizations are turning to scenario analysis. They’re determining the financial and operational effects of potential events and planning for contingencies to ensure the continued viability of the organization. Some are moving beyond planning and taking pre-impact actions such as diversifying supply chains and securing alternate sources of critical inputs.

Audit committees will want to ensure that management has a thorough understanding of the risk environment and a process for regularly reassessing it. They should assess management’s scenarios for robustness and reasonableness, and question managers of the finance and internal audit functions on their contingency plans in the case of a major disruption.

Economic and geopolitical forces are ever-present and continuously changing the environment in which organizations operate. Audit committees can play a key role through their traditional oversight of the finance function, particularly as it pertains to ensuring the reasonableness and robustness of forecasts and assumptions.