EFFECT OF INTERNAL AUDITING ON PERFORMANCE OF MICROFINANCE INSTITUTIONS:

A CASE STUDY OF STAGE WELFARE SACCO, ENTEBBE

ABSTRACT

This study investigates the effect of internal auditing on the performance of microfinance institutions (MFIs), using Stage Welfare SACCO, Entebbe as a case study. The research examines how internal audit functions — including audit planning, internal control evaluation, compliance monitoring, and audit reporting — influence financial performance, operational efficiency, loan portfolio quality, and member satisfaction. A cross-sectional, mixed-methods design was used: quantitative data were collected via structured questionnaires (n = 120) and secondary financial records (5 years), while qualitative data were obtained from 8 key informant interviews (management, audit staff, and members). Data analysis involved descriptive statistics, Pearson correlation, and multiple regression. Findings (illustrative) show a positive and statistically significant relationship between robust internal auditing practices and improved performance indicators — notably lower non-performing loans (NPLs), better compliance, and higher operational efficiency. Recommendations include strengthening internal audit capacity, formalizing audit follow-up procedures, and integrating audit findings into strategic planning. Limitations and suggestions for future research are discussed.

TABLE OF CONTENTS

1. Introduction

2. Literature Review

3. Theoretical Framework

4. Research Methodology

5. Data Analysis and Findings (illustrative)

6. Discussion

7. Conclusions and Recommendations

8. Limitations of the Study

9. References

10. Appendices (Questionnaire & Interview Guide)

1. INTRODUCTION

1.1 Background of the Study

Microfinance institutions (MFIs) and savings and credit cooperative organizations (SACCOs) play a critical role in financial inclusion and poverty reduction, particularly in developing countries. Performance and sustainability of these institutions depend not only on client outreach but also on sound governance, internal controls and risk management. Internal auditing is a key governance mechanism that evaluates the adequacy and effectiveness of internal controls, risk management, and governance processes — all of which can materially influence institutional performance.

1.2 Problem Statement

Stage Welfare SACCO, Entebbe, like many small MFIs, faces operational risks such as loan default, fraud, weak compliance, and inefficiencies. While the SACCO has an internal audit function, management is uncertain how effectively the internal audit contributes to improved performance. This uncertainty creates a need to empirically assess the relationship between internal auditing and SACCO performance.

1.3 Research Objectives

Main objective

To determine the effect of internal auditing on the performance of Stage Welfare SACCO, Entebbe.

Specific objectives

1. To assess the level of implementation of internal audit practices at Stage Welfare SACCO.

2. To examine the relationship between internal auditing and financial performance (profitability, liquidity, NPLs) of the SACCO.

3. To evaluate the influence of internal auditing on operational efficiency and member satisfaction.

4. To recommend measures to enhance the positive impact of internal auditing on the SACCO’s performance.

1.4 Research Questions

1. What is the level of internal audit implementation at Stage Welfare SACCO?

2. What is the relationship between internal auditing and the SACCO’s financial performance?

3. How does internal auditing affect operational efficiency and member satisfaction?

4. What strategies can strengthen the impact of internal auditing on performance?

1.5 Significance of the Study

The study provides management and the board of Stage Welfare SACCO with evidence on the internal audit’s value, guiding resource allocation and governance reforms. Regulators, other SACCOs, and researchers can use findings to improve audit practices and member protection.

1.6 Scope of the Study

Geographically: Stage Welfare SACCO, Entebbe.
Temporally: Financial and audit records for the most recent five (5) years (e.g., 2019–2023) where available.
Conceptually: Focus on internal audit functions and performance metrics (financial, operational, member satisfaction).

2. LITERATURE REVIEW

2.1 Conceptual Definitions

• Internal Auditing: An independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve risk management, control, and governance processes.

• Performance of MFIs: Measured across financial outcomes (profitability, return on assets/equity, liquidity), portfolio quality (NPL ratio), operational efficiency (cost-to-income ratio), and member/customer satisfaction.

2.2 Empirical Studies

• Studies across developing countries typically find a positive association between strong internal control frameworks (including internal audit) and better financial performance, lower fraud incidence, and improved compliance.

• Research on small financial cooperatives emphasizes that internal auditing is often under-resourced, reducing its effectiveness unless supported by the board and senior management.

• Effective internal audit has been linked to reductions in NPLs, improved loan recovery, faster detection of irregularities, and enhanced regulatory compliance.

2.3 Gaps in Literature

While literature supports a positive link between internal auditing and performance, fewer studies focus specifically on SACCOs in Uganda and localized contextual challenges (e.g., volunteer boards, limited audit budgets).

3. THEORETICAL FRAMEWORK

3.1 Agency Theory

Internal auditing reduces information asymmetry between management (agents) and members/board (principals) by providing independent assurance on controls and financial reporting.

3.2 Institutional Theory

Organizational practices (like internal auditing) are shaped by regulatory, normative, and cultural pressures; adoption and effectiveness depend on institutional support and norms.

These theories inform hypotheses that stronger internal audit functions lead to better performance via improved oversight and adherence to standards.

4. RESEARCH METHODOLOGY

4.1 Research Design

A mixed-methods cross-sectional design combining quantitative and qualitative approaches to gain breadth and depth.

4.2 Population and Sampling

• Population: All Stage Welfare SACCO staff, board members, internal audit personnel, and a sample of members.

• Sample size: 120 respondents for structured questionnaires (stratified across management, audit staff, and members), plus 8 purposively selected key informants for interviews. (If the SACCO’s membership is larger, sampling can be adjusted using Cochran’s formula.)

4.3 Data Collection Instruments

• Questionnaires: Structured with Likert-scale items to capture perceptions of internal auditing activities and perceived impact on performance.

• Interview Guide: Semi-structured for management, audit staff, board, and members.

• Document Review: Annual reports, internal audit reports, loan portfolio data, and financial statements for the last five years.

4.4 Measurement of Variables

• Independent variable: Internal auditing (measured using composite score covering audit planning, independence, scope & coverage, follow-up, and reporting quality).

• Dependent variable: Performance (composite of financial performance indicators — ROA, NPL ratio, liquidity ratio — and operational indicators — cost-to-income ratio, member satisfaction score).

4.5 Data Analysis Techniques

• Descriptive statistics: Mean, standard deviation, frequencies.

• Inferential statistics: Pearson correlation to assess relationships; Multiple linear regression to estimate the effect of internal auditing (and control variables like institution size, staff competence) on performance.

• Qualitative analysis: Thematic analysis to triangulate quantitative findings.

4.6 Validity and Reliability

• Pretesting questionnaire on a small group; Cronbach’s alpha to test internal consistency (target α ≥ 0.7). Content validity ensured through expert review.

4.7 Ethical Considerations

Confidentiality, voluntary participation, informed consent, and data anonymization were ensured.

5. DATA ANALYSIS AND FINDINGS (ILLUSTRATIVE)

NOTE: The tables and statistics below are illustrative examples showing how results might be presented. Replace with actual collected data for formal reporting.

5.1 Respondent Characteristics (n = 120)

• Gender: 54% female, 46% male.

• Roles: Members (60%), Staff (20%), Audit personnel (8%), Board members (12%).

• Average membership duration: 5.3 years.

5.2 Descriptive Statistics — Internal Auditing Components (Likert scale 1–5)

5.3 Performance Indicators (past 5 years — illustrative averages)

Trend: improvements in ROA and NPLs coincide with observed strengthening of audit activities (e.g., adoption of formal audit plan in 2021).

5.4 Correlation Analysis

Pearson correlation between composite internal audit score and key performance metrics (illustrative):

• Internal Audit vs NPL ratio: r = -0.62 (p < 0.01) — stronger internal audit associated with lower NPLs.

• Internal Audit vs ROA: r = +0.48 (p < 0.01).

• Internal Audit vs cost-to-income: r = -0.35 (p < 0.05).

• Internal Audit vs member satisfaction: r = +0.51 (p < 0.01).

5.5 Regression Analysis (Multiple Linear Regression)

Dependent variable: Performance Index (standardized composite of ROA, inverse NPL, cost-to-income inverse, member satisfaction).

Model (illustrative):
PerformanceIndex = β0 + β1(InternalAuditScore) + β2(Size) + β3(StaffCompetence) + ε

Estimated coefficients (illustrative):

• β0 (Intercept) = 0.12 (p = 0.48)

• β1 (Internal Audit Score) = 0.42 (p < 0.001)

• β2 (Size, ln of total assets) = 0.18 (p = 0.04)

• β3 (Staff Competence index) = 0.27 (p = 0.01)
  Adjusted R² = 0.49

Interpretation: A one-unit increase in the internal audit score is associated with 0.42 increase in the performance index, controlling for size and staff competence. The model explains ~49% of performance variability (illustrative).

5.6 Qualitative Findings (themes)

• Audit independence needs strengthening: Audit reports are sometimes delayed and recommendations not fully implemented due to resource constraints.

• Value of audit follow-up: Where follow-up was systematic, management corrected loan documentation lapses and improved recovery.

• Capacity gaps: Internal audit staff require ongoing training in risk-based auditing and IT controls.

• Member confidence: Members reported increased confidence when audit reports were summarized and shared at AGMs.

6. DISCUSSION

The (illustrative) results align with broader literature indicating that robust internal auditing positively influences institutional performance by strengthening controls, reducing fraud and default, and improving operational efficiency. The negative correlation with NPLs suggests that effective auditing helps identify weak lending practices earlier and enforces corrective action. However, the strength of this relationship depends on audit independence, breadth of scope, timeliness of reporting, and the management’s commitment to act on recommendations.

The regression results indicate that internal audit is a significant predictor of performance even after controlling for size and staff competence, highlighting audit’s unique contribution. Qualitative themes underscore that audit efficacy is constrained by resource limitations, limited follow-up, and capacity gaps — common issues in small SACCOs.

7. CONCLUSIONS AND RECOMMENDATIONS

7.1 Conclusions

1. Internal auditing at Stage Welfare SACCO has a positive association with improved financial and operational performance (illustrative finding).

2. Key audit strengths include established audit planning and reporting; weaknesses include inconsistent follow-up and limited capacity.

3. Management responsiveness to audit findings is critical; where action was taken, performance improved.

7.2 Recommendations

For Stage Welfare SACCO (practical & prioritized):

1. Strengthen internal audit independence: Ensure the internal auditor reports functionally to the board (or audit committee) to reduce management interference.

2. Formalize follow-up mechanisms: Create a tracker for audit recommendations, with timelines and responsible owners; present updates quarterly to the board.

3. Capacity building: Invest in continuous training for internal audit staff — including risk-based auditing, credit audits, and IT controls. Consider periodic external quality assessments.

4. Risk-based audit approach: Transition from routine checklist audits to risk-focused audits that prioritize high-risk processes (loan disbursement, recoveries, treasury).

5. Enhance communication: Summarize significant audit findings for members during AGMs to boost transparency and member trust.

6. Leverage technology: Adopt simple MIS enhancements to automate key controls (loan approval workflows, limit checks), reducing manual errors.

7. Budgetary support: Allocate an adequate audit budget to enable independent reviews and procure necessary tools.

7.3 Policy Implications

Regulatory bodies overseeing SACCOs could provide guidelines or standards for internal audit practices tailored to small MFIs, including minimum competencies and reporting lines.

8. LIMITATIONS OF THE STUDY

1. Data scope: This case study focuses on a single SACCO; findings may not fully generalize across diverse SACCOs.

2. Cross-sectional design: Limits ability to infer causality — longitudinal studies would better establish causal effects.

3. Illustrative results: Unless actual primary and secondary data are collected, numerical results presented here are illustrative and should be replaced with empirical data.

9. SUGGESTIONS FOR FUTURE RESEARCH

1. Conduct a longitudinal study across multiple SACCOs in Uganda to assess causal impact of internal audit reforms over time.

2. Evaluate the cost-benefit of investing in internal audit capacity in small MFIs.

3. Study the role of external audit and its interaction with internal audit in improving performance.

10. REFERENCES

(Include actual, properly formatted references when preparing the final thesis. Below are common references you may consider citing and replacing with specific editions and pages.)

• Arens, A. A., Elder, R. J., & Beasley, M. S. (2017). Auditing and Assurance Services: An Integrated Approach.

• Institute of Internal Auditors. (2017). International Standards for the Professional Practice of Internal Auditing.

• Atrill, P., & McLaney, E. (2017). Accounting and Finance for Non-Specialists.

• Muriithi, K., & Wanjau, K. (2016). “Internal Audit Functions and Financial Performance of SACCOs in Kenya.” Journal of Accounting and Taxation.

• Onyango, J. (2018). “Governance, Internal Controls and Performance i