In order to answer this question we need clarity on the subject of internal controls and begin with proper definitions to understand what an efficient internal control system is. By literal definition, this system is solely intended to help you maintain healthy business practices and keep a check on the progress and achievements of the company. The internal control system plays a very integral role in the company’s success and all entrepreneurs, old and new, should be aware of its implementation. It also helps you steer clear of the risk of any kind of malpractices or frauds. Several surveys indicate that companies lose almost 5 percent of their annual revenue to occupational frauds and the organization with a staff of 100 or less are more likely to be subjected to such events. A strong internal control system protects you from suffering these kinds of losses.
Define Your Objectives To Set-Up Effective Internal Control
If and when you decide to create an internal control system the first step should be to layout your objectives. List down the risks and contingencies, the assets that need protection and the responsibilities of each staff member. This will act as a guideline for your setup and make the process smooth and easy. You also need to have a look at the policies and regulations of the government that apply to your sector and make sure that your company complies by the same. For example, organizations working in the health care sector need to adhere to the Health Insurance Portability and Accountability Act of 1996 (HIPAA).
Some Basic Aspects Of Internal Control
The textbook definition of internal controls bifurcates into five bases of internal control that should be covered thoroughly. The core values if any company revolves around governance, risk & compliance. When you focus on addressing risks along with making sure that all the processes are in force, good physical access control, as well as systemic control, are to be kept in mind. Internal control systems provide effective risk management to support the procedures that protect your resources and assets.
Five Internal Controls That Are Of Importance
Control environment – This lays the foundation of your internal controls. This is reflected in the integrity, ethical values, management philosophy and the assignment of authority that are covered under the control environment. Proper formalization and segregation of duties make the management accountable.
Risk assessment – As mentioned before the most important aspect of internal controls is to evaluate your business flow and exposure to risk. A thorough lookout both internally and externally helps to accurately define the risks. You should consider this as an exercise for contingency planning.
Control Activities – The activities like creating the company policies, procedures and workflow are essential as well. This will also include top-level reviews and designate the duties. The control activities need to be documented in a proper manner which reflects on their efficient management of risks.
Information and Communication – There should be a free flow of information in all directions, be it upwards or downwards so that the management can generate proper policies as well as ensure their diligent implementation.
Monitoring – This is the aspect that puts your internal controls to test. There should be a board that consists of members appointed from outside and are independent of the organization and has the financial expertise to conduct an inspection.
Safeguard Your Assets And Accomplish Operational Efficiency
Suitable internal control systems quickly identify errors and frauds if they occur. The main aspect i.e. segregation of duties prevents one person from requesting, authorizing verifying and recording business expenditure. Also, credible financial data enables the company to complete its duties of filing proper taxes as well as meet any financial reporting obligations like loan covenants.