Internal Controls: How To Use Them And Why Private Companies Should Adopt Them

For privately held companies, it’s critical to take steps to safeguard your organization from fraud and other risks that may negatively impact your operations. An effective way to help your organization mitigate risks and achieve its objectives is through internal controls. Internal controls address risks, encourage compliance with policies, regulations and laws, ensure accurate financial record-keeping and reporting, and support efficient, streamlined operations.

What exactly are internal controls? According to the Committee of Sponsoring Organizations’ (COSO), an internal control is defined as “a process, effected by an entity’s board of directors, management, or other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance.”

In the remainder of this blog, we will explore how internal controls help you address risks, stay organized, operate more efficiently and achieve financial goals.

HOW TO USE INTERNAL CONTROLS:

It may seem daunting to start from square one when implementing internal controls, but not to fear – there are effective procedures you can utilize to integrate them from the ground up. The first step is to conduct a risk assessment of your organization to identify operational areas that are most prone to errors or issues.

Once you’ve determined key risk areas of your company, it’s time to decide which type of internal controls will be most effective for your organization. Just as your company is unique in its business model, size, revenue, structure and other features, internal controls also come in a variety of forms: automated or manual, preventative or detective.

Manual controls are procedures performed by individuals without full reliance on an IT system for execution of the control. Manual controls may include requiring signatures on documents or other tasks that are performed by individuals and not technology. Automated controls can be more reliable than manual controls because they are programmed in an IT system and are not prone to human error.  Automated controls are implemented when systems are configured to perform specific tasks, such as identifying fraudulent activity, forcing workflows or approvals and backing up critical data.

Internal controls should include a balanced mix of Preventative and Detective controls.  Preventative controls put safeguards in place to prevent risks to objectives, such as authorization prior to paying invoices, approval of journal entries prior to posting, or passwords to ensure access to company data is protected.  Detective controls involve review or validation of transactions or data after they have occurred or have been recorded to identify and correct risks to objectives, such as review of bank reconciliations or period over period variance review of financial statements.

Now that you understand the basics of internal controls, let’s dive in to how they can help your organization.

FOUR WAYS INTERNAL CONTROLS HELP YOUR ORGANIZATION

Improve Reliability of Financial Reporting for Private Investors and Financial Institutions

Key business partners may require certain compliance-related tasks that private organizations need to comply with for the relationship to continue. For example, a financial institution may require audited financial statements and for the company to have an established board of directors or Sarbanes-Oxley (SOX) compliance before lending to that organization.

Internal controls also establish a clear segregation of duties, creating a system of checks and balances among employees and their responsibilities that is visible to executives and stakeholders. Clear designation of employees’ responsibilities creates a culture of accountability and – especially when it involves company financial reporting – reduces opportunities for fraud.

Prepare Company for Initial Public Offering (IPO) or Acquisition by a Special-Purpose Acquisition Company (SPAC)

Internal controls establish procedures that will be required when a company becomes public, so a company with internal controls will be that much more prepared if the possibility of a transaction becomes a reality. A strong implementation of controls increases company value for any future transactions such as private equity, merger or an acquisition.

Improve Compliance with Laws and Regulations

State or federal governments may require a company to certify that they are in compliance with certain laws and regulations prior to approving government contracts. If this applies to your business, internal controls are a surefire way to lessen the likelihood of experiencing issues when forming government contracts.

In addition to complying with laws and regulations, internal controls can improve operational efficiency by improving the accuracy and timeliness of financial reporting.

Reduce Fraud Risk

Financially,  internal controls are a major benefit because they can be automated to streamline a company’s financial operations such as reports, audits, transactions, billing and invoicing.

Internal controls serve as a blueprint of an organization’s inner operations, which helps pinpoint exactly where and how risks, such as fraud or breach, may occur — and also map out exactly what is being done to address those risks. As a result, employees will have more clearly designated responsibilities, so it’s easier to spot when a breach occurs or a company resource is misused.

MOVING FORWARD

Failing to integrate internal controls can lead to any number of challenges: negatively impacted audit results, data breaches, disruptions to business operations, damage to organization’s reputation, and loss of revenue, to name but a few. It can be difficult to figure out exactly how and where you need to use them – but one of Addison Group’s consulting brands, Bridgepoint Consulting, has extensive experience in implementing internal controls that match an organization’s specific needs.

If you are seeking guidance in revamping your business processes and building the roadmap to a more optimized financial future, get in touch today.