Internal controls play an essential role in an organization’s success. However, an alarming number of finance and accounting professionals start their businesses without having an internal control framework.
Why are Internal Controls Important?
An internal control framework helps businesses accomplish vital objectives, improve and sustain optimal performance, and reduce risk and exposure. It’s important that business owners put procedures in place that protect their financial and management information, in accordance with the federal and state laws and regulations. Internal controls create a system for how a business handles receiving and reporting revenue, and management and administrative tasks.
Components of an Internal Control Framework
The following five key components of a highly effective internal control system encourage the achievement of a business’s mission, strategies, and objectives.
1. Control Environment
A good control environment foundation includes an organized management structure, and effective Human Resource policies and procedures. By establishing internal controls, business owners establish protocols that their consultants and staff are required to follow. The employees are informed of these protocols and are expected to follow them as they carry out their daily work duties. The established protocols in a controlled environment will develop cohesiveness and order for businesses because everyone knows what is expected of them.
2. Risk Assessment and Mitigation
Every business entity encounters risks from internal and external sources that need to be assessed to be successful. Risk assessment is defined as the identification and analysis of associated risks to achieve objectives. They lay a foundation for identifying how the risks should be handled. Because operating, economic, industry and regulatory conditions will continue to change, systems are necessary to discover and address the risks associated with those changes. An effective internal control framework is the most important step when it comes to mitigating any involved risks.
3. Control Activities
All personnel play a part in the organizational representation of internal controls, regardless of whether their work responsibilities are directly related or not. Responsibilities should be divided between different employees to lower the risks of errors or improper actions. For instance, responsibilities for receiving checks or cash, and reconciling deposits, need to be separated. Also, transactions should always be authorized and approved to ensure that the process is consistent with institutional or departmental goals and objectives.
4. Information and Communication
Successful information and communication systems can be formal or informal, ranging from informal staff meetings to sophisticated computer technologies. The purpose of both styles is to provide input, feedback, and data that is relative to operations, compliance objectives and financial reporting. An additional factor is the informal conversations with customers, regulators, employees, and suppliers that have the potential of providing critical information about opportunities and risks.
The monitoring of an internal control framework is executed by separate and ongoing evaluations that determine if other elements of internal control are continuing to function as intended. The outcomes should be communicated to the people responsible for taking the appropriate, corrective action. Serious issues should be communicated to management level personnel or the board of directors.
Unfortunately, some businesses don’t recognize the need for an internal control framework until it’s too late. When important information and data is in the right hands, it can be an extremely beneficial tool. If that critical data is placed in the wrong, deceptive or inexperienced hands, and used in an uncontrolled environment, it can lead to the crippling or end of the business. For this reason, having an internal control framework in place is critical.
Contact us when you are ready to develop your internal control framework.