Internal Controls: How to Establish Control Over Your Business
Internal controls cover a vast amount of concepts, standards, and practices that are meant to strengthen your business and reach your overall objectives with ease without micromanaging.
You can customize your internal control activities to monitor the effectiveness and efficiency of your business's activities in various operations as well as compliance and reports.
Internal controls yield many benefits. The key benefits include improved effectiveness and efficiency of operations, better information for decision-making, and increased confidence in running your business. Keep reading to learn more about how internal controls can benefit your business!
Internal Controls: A Closer Look
Internal controls, which are often referred to as "control activities," are procedures that help assure your team is working as they should and delivering results.
These controls include the recording of transactions, maintaining records, and helping prevent or detect any unauthorized acquisition, use, or disposition of your company's resources.
They monitor the effectiveness and efficiency of business activities in the areas of operations (Operations), financial reporting (Reporting), and compliance with applicable laws and regulations (Compliance).
Today, we’ll dive into risk assessment, control environment, and anti-fraud considerations.
Risk Assessment
Through risk assessment, you can determine the degree to which internal controls should be implemented in your business. Your assessment of business risks is made for each of your company’s major “business cycles” which are defined as the results from the series of cash inflows and outflows that are reported or disclosed in your financial statements.
Common business cycles include, but are not limited to, the following:
Revenues and accounts receivable
Purchases and accounts payable
Manufacturing and inventory
Payroll and benefits
Treasury management
Internal management and external financial reporting
Compliance with tax laws and regulations
Each business cycle has an associated level of risk that fraud and/or a material misstatement in your company’s financial statements could occur. You’ll determine the nature, timing, and extent of the internal control activities your business needs based on your assessment of risk for each major business cycle of your business.
For example, in some companies, purchases of goods and services from vendors are significant in dollar amounts, and many employees participate in the process. In these cases, the nature, timing, and extent of internal control activities that support the purchasing will be different from a company run by a sole proprietor.
How to assess business risk
When you’re assessing your business risk, consider both quantitative and qualitative factors, such as:
Who uses the financial statements (i.e. banks, shareholders, suppliers, employees, customers, regulators)
Size of the financial statement items (i.e. assets, liabilities, revenues, net income)
The uniqueness of the transaction(s)
Difficulty in valuing the amount of a specific transaction
Trends in earnings, revenues, and cash flows
You should implement internal controls to prevent or detect errors or fraud that could result in material misstatements based on your consideration of both qualitative and quantitative factors.
Control Environment
The control environment is the overall “tone-at-the-top” for your business. It’s the foundation for all other components of your internal control system. There are seven sub-components of your company’s control environment that establishes its “tone-at-the-top.”
The seven sub-components are:
Integrity and ethical values
Commitment to competence and development of people
Your philosophy and operating style
Organizational structure
Assignment of authority and responsibility
Talent Management policies and procedures
Participation by those charged with governance (i.e., board of directors)
When evaluating your company’s control environment, there are a handful of factors you should consider. Keep an eye out for your specification of the level of competence needed for particular jobs and the ultimate fulfillment of those specifications, your conveyance that integrity and ethical values cannot be compromised and assurance that employees will receive and understand that message, and your continuous demonstration, through words and actions, of a commitment to high ethical standards.
Other specifications to consider include:
A philosophy and leadership style that has a pervasive, positive effect on your business
An organizational structure that is not so simple that you can’t adequately monitor your company’s activities nor so complex that the structure inhibits the necessary flow of information throughout the organization.
Your understanding of your control responsibilities and possession of the experience and knowledge needed to run your business
Your willingness to assign responsibility, delegate authority, and establish policies that provide a basis for accountability and control and set forth employees’ respective roles and responsibilities within your business
Talent management policies that are central to recruiting and retaining competent people who will enable your company to carry out its plans and achieve its goals
Anti-Fraud Considerations
As a business owner, you’re responsible for designing controls and periodically reviewing compliance based on your assessment of the risk of a material misstatement occurring in your company’s financial reporting. If you believe the risk of fraud has a possible likelihood of having a material effect on your company’s financial position, you should implement an anti-fraud program. All controls should be evaluated in order to address the risks of fraud while including a possible likelihood of having a material effect on your company’s financial statements.
An effective anti-fraud program should include the following key elements:
Code of conduct/ethics
Hotline/whistleblower program
Hiring and promotion (i.e., background checks)
Investigation and remediation of identified fraud
Oversight by the board of directors
Risk assessment
Questions to Consider in Regards to Establishing Internal Control
Now that we’ve discussed a few crucial examples of internal controls, it’s time for you to consider the following:
Are you committed to integrity and ethical values?
Do you act to remove or reduce incentives or temptations that might prompt you or your employees to engage in dishonest, illegal, or unethical acts?
Are incompatible duties appropriately segregated within your organization?
Are your policies and procedures clear and are they issued, updated, and revised on a timely basis?
Do you give appropriate attention to internal controls?
Whether you answered yes or no to these questions, Ametra Advisors can help to set up and monitor internal controls to help your business succeed. Give us a call today to learn more!