Internal controls play a crucial role in the success of any company. Are you concerned about the effectiveness of your company's internal controls? Or looking for ways to improve and strengthen them?
This post provides essential knowledge about internal controls—with accounting controls as a specific example—and then lists 7 best practices that can help you:
- safeguard your assets
- minimize the risk of fraud
- and enhance your operational efficiency
You can also download our complete guide to AP internal controls here.
What are internal controls?
Internal controls are just what they sound like—controls that are applied internally, meaning within your organization—as a way to ensure things like accuracy, reliability, and compliance in everything from data management to day-to-day operations.
What are internal controls in accounting?
By that definition, internal accounting controls are the measures and processes that ensure the accuracy, reliability, and integrity of an organization's financial information.
These controls establish policies and procedures to protect assets, help prevent fraud, and promote compliance with financial laws and regulations.
The goal of internal accounting controls is to provide reasonable assurance that financial transactions are recorded accurately and that financial statements are prepared in accordance with applicable accounting standards.
Who usually oversees internal controls?
The responsibility for managing financial control systems usually falls on the finance or accounting department. These departments are responsible for establishing and maintaining effective internal controls to ensure the accuracy and reliability of financial reporting. To do that, they develop and enforce the policies, procedures, and protocols for recording financial transactions and monitoring financial activities.
Additionally, the finance or accounting department is responsible for reviewing and evaluating the effectiveness of these internal control systems regularly to identify any weaknesses or areas for improvement. Ultimately, their goal is to minimize the risk of fraud, errors, and misstatements in financial statements, and to ensure compliance with applicable laws and regulations.
Two types of internal controls for your organization
Internal controls perform two types of jobs—preventing problems from happening in the future and discovering issues that already exist.
- Preventive controls are designed to identify and address potential issues or weaknesses in processes, systems, and operations before they occur. They protect companies by preventing errors, loss, and even criminal behavior.
- Detective controls uncover fraud, errors, or irregularities within an organization's operations. These controls include monitoring, auditing, and investigation to detect anomalies or violations of established policies and procedures.
What are the main purposes of internal controls?
Internal controls serve several purposes:
First and foremost, internal controls help safeguard your organization's assets and minimize the risk of mistakes, fraud, and theft. By implementing internal controls, companies can ensure that their financial information is accurate and reliable.
Additionally, internal controls help promote operational efficiency and effectiveness by establishing clear procedures and guidelines for employees to follow. This leads to better overall business performance and helps streamline your accounting systems.
Finally, internal controls play a crucial role in ensuring compliance with laws and regulations—not just for individual actors but for the company as a whole. By creating policies and guidelines for employees to follow, internal controls also promote ethical behavior generally, both within the accounting department and throughout the organization.
Why are internal controls important?
For most people, our own best interests are very much in line with our employer's best interests. We want our organizations to succeed because we want to keep our jobs, enjoy healthy raises and bonuses, and maintain job security. But even when our intentions are in the right place, we can still make mistakes.
When individual team members are tired, distracted, or just having a bad day, a strong internal control structure can provide the checks and balances needed to prevent accounting errors.
These internal control activities range from reviewing financial reports and accounting records to physical audits of your warehouse inventory. In every area of your organization, internal control procedures are intended to limit relevant risks and ensure effective operations.
Limitations of internal controls
At the end of the day, there's no such thing as a perfect employee—never tired, always impeccably careful, ever-adhering to the ethical values of a patron saint. In other words, even the most well-intentioned people can make mistakes. The right internal control framework (think bank reconciliation or quality control) provides the checks and balances that can prevent honest errors.
But internal controls have at least two main limitations that every company should be aware of:
- Bad actors. If your internal controls are up against an intentional bad actor, actively looking for ways to sabotage your operations, there's only so much you can do. Focus your efforts on your organization's biggest risks, and perform a risk assessment on any new hires.
- Going too far. Companies that take internal controls to an extreme won't keep good people for very long. Employees want to feel important to their organizations—micro-managing tends to do the opposite. So the key to a successful internal control structure is to expect strict adherence to a set of reasonable policies.
To learn more, stream our webinar on 9 internal control issues that are often overlooked.
Best practices: 7 internal controls for any organization
Each of the principles and best practices below can be implemented in various ways depending on what's best for your organization's unique situation. The important thing is to be sure that your policies are clear and that your controls are being followed.
1. Segregation of duties
Segregation of duties (SoD)—also known as separation of duties—is a fundamental element of internal controls designed to minimize fraud and errors. By distributing responsibilities associated with various tasks, no single person holds all the power, thereby reducing the potential for misuse.
For example, an employee who accepts cash from customers should not be the same person who counts and reports that cash. And the employee tasked with recording financial transactions should not be the one to approve financial transactions.
This separation ensures a system of checks and balances within your corporate accounting function, minimizing the simple risk of human error as well as fraud.
2. Standardized operating procedures
Standardized operating procedures (SOPs) ensure consistency, accuracy, and compliance in the execution of financial processes. These written procedures outline the steps that must be followed for each task, thereby reducing the risk of errors and mismanagement.
To implement SOPs, document the correct procedures for all financial operations—including your segregation of duties—and train your staff on them. Regularly review and update your SOPs to reflect any changes in regulations or business operations.
3. Periodic financial reconciliations
Reconciling the books regularly will help ensure that your company's financial records match up with bank statements, invoices, and other external financial statements. Regular reconciliation helps to catch any discrepancies, errors, or potential fraud early.
The key is to establish a consistent schedule for carrying out reconciliations. This could be daily, weekly, or monthly depending on the volume and complexity of transactions. Using automated reconciliation software can help streamline the process and improve accuracy.
4. Regular internal audits
Regular internal audits are intended to examine and verify the company's financial operations. They ensure compliance with your standardized operating procedures as well as external regulations.
Internal audits can be run by an independent auditor within the organization, or you can hire independent consultants to perform external audits for you. Either way, be sure to set up a regular audit schedule (such as annually or semi-annually), and review the auditor's reports to see if any action is required.
5. Documentation and record-keeping
Good documentation and record-keeping procedures provide a clear audit trail for all financial transactions. This aids in transparency and accountability, and it ensures that transactions can be traced from beginning to end through your accounting procedures.
Make sure your standardized operating procedures include recording every touchpoint of your accounts payable, accounts receivable, spend, and expense management processes. Using a formal document management system to store, organize, and track documents electronically also makes document retrieval easier and more efficient.
6. Strict access controls
Strict access controls ensure that only authorized personnel have access to sensitive financial data and systems. This can significantly reduce the risk of unauthorized access, data manipulation, and theft. It also helps in implementing your segregation of duties.
Be sure to establish user roles and permissions in your financial systems and regularly review and update these permissions. Using strong password policies and multi-factor authentication can also enhance the security of your systems.
7. Automation and technology
Using automation and new technology such as artificial intelligence (AI) and machine learning (ML) can significantly enhance the accuracy and efficiency of accounting processes. It can reduce manual errors, improve data analysis, and free up time for staff to focus on more strategic tasks for your organization.
Evaluate existing processes to identify areas that can be automated. Then, invest in reliable software that fits your business needs. Technology can also help you implement your policies and controls across distributed financial teams.
Improve internal controls with BILL
BILL helps companies automate their financial operations, applying all of these principles (and more) without all the manual effort.
- Assign roles for built-in access control and segregation of duties
- Automate your approval procedures and apply them automatically
- Integrate with your accounting software to make reconciliation easy
- Get an automatic audit trail of every transaction touchpoint
- Enjoy unlimited record-keeping and document storage
If you want to apply better internal controls in your financial operations and help your team work more efficiently, explore how BILL applies internal controls automatically.