Internal Controls

How does a business owner have confidence that the business is operating as planned, without being worried about inaccurate financial information or that assets are not properly conserved.  The answer, install a system of internal controls.  But what is a system of control and what are the features of an effective internal control system?

Controls are put into place in order to deter otherwise honest people from doing things that are financially harmful to a business, such as “borrowing” monies belonging to the business to be spent for personal uses or helping themselves to supplies or inventory items.  A system of controls can take many forms, some of which are described below.

Separation of duties:  The risk of fraud can be reduced significantly if parts of various business functions are assigned to multiple people.  For example, it is generally accepted that the person performing the record keeping should not handle money or have the authority to sign checks.

Responsibility:  When people are given the authority to perform various takes, they must also held accountable for performing the assigned tasks.  No system of internal control can be effective unless those performing the tasks know that they will be held responsible for the successiful implementation of the internal control.

Systems knowledge:  In order for a system of controls to be effective, employees must have an understanding of how the system is supposed to operate.  This requires an ongoing training program to ensure that business process of adequately understood and the training updates are periodically provided.

Error Reporting:  Unless some process is in place to inform management of the failure of controls, there is no way to know whether a particular control is effective or not.  Not only must there be a process for reporting errors, but management must continually monitor the reporting system to determine when controls have become ineffective and need to be revised.

A system of internal controls is vital to ensure that the assets of the business are secure and the risk of loss is minimal.  A limited number internal controls have been described, but be aware that several other exist that were not discussed due to space limitations.

The principles underlying this post were taken from the CFO Guidebook, by Steven M. Bragg.

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