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Fundamental Model

In this section we introduce our Fundamental Model.  Let us start by supposing that an organisation carries out a range of business activities.  Let the cost of such activity be C_ba. Cost may be expressed in terms of money and/or resources (e.g. volunteer work). It will generate some business benefit B. If the organisation is a company, then B corresponds to profit, P, and is related to the cost of the business activities through revenue R:

P = R – C_ba

The organisation deploys an Internal Control System (ICS). This has an associated cost, C_ics, which increases the cost of doing business

C_ba + C_ics

In the context of a company this has the effect of reducing profit, see Figure 1. 

Figure 1: Impact of ICS cost on profit

Let E be a set of events: E = {e₁, e₂, e₃, ... e_j, ...}.

Each event e_j occurs at some time Te_j and if the damage that it causes is not fixed by time Tf_j, where Tf_j is less than some time Tw_j  (where ΔTw_j = Tf_j - Te_j  is referred to as the time window), the event will cause a loss of business benefit, Ip_j (referred to as the impact penalty).  See Figure 2.

Figure 2: The onset of an impact penalty expressed in terms of financial loss

The impact penalty may take a variety of guises. For example, it could:

• arise in the form of liquidated damages or the cost of borrowing money to replace missing revenue or assets.

• correspond to reduced revenue because customers do not pay for goods or services already received or in production (e.g. as with a stage payment). 

• contain hidden costs (which accumulate in Cf_j, see below), for example because customers demand more attention.

• be in a form that is impossible to interpret in financial terms, such as loss of life, loosing the election or a court case.

Moreover, the event may also have an immediate impact on the net worth of the organisation, for example because property is destroyed or money is stolen.  For simplicity, we model these asset losses as an impact penalty.  As shown in the insert in Figure 2, there may also be consequential impacts, for example other customers in the future do not buy, the stock markets collapse, there is a general strike, etc.

The objective of an ICS is to control activities and detect unwanted results. An ICS is never perfect and therefore certain events will not be detected by it.   Those it does detect are detected at times Td_j (where  Te_j  <  Td_j ).  See Figures 3 and 4.

Figure 3: Detecting the event in good time to avoid the impact penalty. Impact expressed in financial terms

Figure 4: Detecting the event too late to do anything about it within the time window. Impact expressed in financial terms

If the ICS does not detect the event, Management is deemed to be cognisant of the event at time Tm_j (where Te_j  <  Tm_j).  See Figure 4.

The cost of the ICS detecting the event is included in Cics.

The cost of fixing the damage caused by the event is Cf_j.  See Figures 3 and 4.

The damage cannot be fixed unless the associated event has been detected, i.e. Td_j  <  Tf_j  and/or Tm_j  <  Tf_j.  See Figures 3 and 4.

The impact of the event depends on when that event is detected.  Specifically:

• When Tf_j  <  Tw_j the impact is Cf_j.  See Figure 3.

• When Tf_j  ³  Tw_j the impact is Cf_j + Ip_j.  See Figure 4.

Note that in this second case the time at which the event is detected TD_j  (or indeed Tm_j) may be within Tw_j. The problem is that the event is detected too late for anything to be done about it within the time window and consequently an impact penalty is incurred as well as the cost of fixing the damage.

The impact of the event could have a widespread effect until the situation caused by the event has been corrected; in extremis putting the organisation out of business, and/or causing widespread damage external to the organisation.  In these cases, see Figure 5, the effect is generally referred to as a disaster and the steps taken to fix it are generally referred to as a Business Continuity Plan (BCP).  Despite the successful deployment of an appropriate BCP, it may be some time before the organisation and/or the environment recovers to a satisfactory state.  Indeed, the impact may be such that the organisation/or the environment never does.

Figure 5: The onset of disaster. Impact expressed in financial terms

Having introduced the basic parameters we are now able to describe the seven classes of control.