How to Use Internal Controls for Your Business, Plus Implementation Tips
For privately held companies, it’s critical to take steps to safeguard your organization from fraud and other risks that may negatively impact your operations.
An effective way to help your organization mitigate risks and achieve its objectives is through internal controls.
What Are Internal Controls in Accounting & Business?
An internal control is defined as “a process, effected by an entity’s board of directors, management, or other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance,” according to the Committee of Sponsoring Organizations’ (COSO).
Internal controls address risks, encourage compliance with policies, regulations and laws, ensure accurate financial record-keeping and reporting, and support efficient, streamlined operations.
In the remainder of this blog, we will explore how internal controls help you address risks, stay organized, operate more efficiently and achieve financial goals.
How to Use Internal Controls in a Business
It may seem daunting to start from square one when implementing internal controls, but not to fear – there are effective procedures you can utilize to integrate them from the ground up.
The first step is to conduct a risk assessment of your organization to identify operational areas that are most prone to errors or issues.
Once you’ve determined key risk areas of your company, it’s time to decide which type of internal controls will be most effective for your organization.
Just as your company is unique in its business model, size, revenue, structure and other features, internal controls also come in a variety of forms: automated or manual, preventative or detective.
Manual vs Automated Controls in business:
- Manual controls are procedures performed by individuals without full reliance on an IT system for execution of the control. Manual controls may include requiring signatures on documents or other tasks that are performed by individuals and not technology.
- Automated controls can be more reliable than manual controls because they are programmed in an IT system and are not prone to human error. Automated controls are implemented when systems are configured to perform specific tasks, such as identifying fraudulent activity, forcing workflows or approvals and backing up critical data.
Other types of internal controls:
- Preventative controls put safeguards in place to prevent risks to objectives, such as authorization prior to paying invoices, approval of journal entries prior to posting, or passwords to ensure access to company data is protected.
- Detective controls involve review or validation of transactions or data after they have occurred or have been recorded to identify and correct risks to objectives, such as review of bank reconciliations or period over period variance review of financial statements.
Now that you understand the basics of internal controls, let’s dive in to how they can help your organization.
4 Ways Internal Controls Help Your Organization:
1. Internal controls improve reliability of financial reporting for private investors and financial institutions
Key business partners may require certain compliance-related tasks that private organizations need to comply with for the relationship to continue.
For example, a financial institution may require audited financial statements and for the company to have an established board of directors or Sarbanes-Oxley (SOX) compliance before lending to that organization.
Internal controls also establish a clear segregation of duties, creating a system of checks and balances among employees and their responsibilities that is visible to executives and stakeholders.
Clear designation of employees’ responsibilities creates a culture of accountability and – especially when it involves company financial reporting – reduces opportunities for fraud.
2. Internal controls help with preparation for Initial Public Offering (IPO) or acquisition by a Special-Purpose Acquisition Company (SPAC)
Internal controls establish procedures that will be required when a company becomes public, so a company with internal controls will be that much more prepared if the possibility of a transaction becomes a reality.
A strong implementation of controls increases company value for any future transactions such as private equity, merger or an acquisition.
3. Internal controls improve compliance with laws and regulations
State or federal governments may require a company to certify that they are in compliance with certain laws and regulations prior to approving government contracts.
If this applies to your business, internal controls are a surefire way to lessen the likelihood of experiencing issues when forming government contracts.
In addition to complying with laws and regulations, internal controls can improve operational efficiency by improving the accuracy and timeliness of financial reporting.
4. Internal controls help reduce risk of fraud
Financially, internal controls are a major benefit because they can be automated to streamline a company’s financial operations such as reports, audits, transactions, billing and invoicing.
Internal controls serve as a blueprint of an organization’s inner operations, which helps pinpoint exactly where and how risks, such as fraud or breach, may occur — and also map out exactly what is being done to address those risks.
As a result, employees will have more clearly designated responsibilities, so it’s easier to spot when a breach occurs or a company resource is misused.
Final Thoughts on Internal Controls for Private Companies
Failing to integrate internal controls can lead to any number of challenges: negatively impacted audit results, data breaches, disruptions to business operations, damage to organization’s reputation, and loss of revenue, to name but a few.
But when implemented correctly, internal controls become instrumental in protecting your business and ensuring accuracy and integrity in every endeavor.
Need Risk Management Support?
It can be difficult to meet rising regulatory demands in a market rife with continually evolving standards. Whether you need help building frameworks for internal controls, regulatory compliance or sustainable governance, our experts are ready to identify and mitigate risk so you can focus on your competitive edge.