Introduction

In a business, internal controls are one of the most crucial, yet least understood, components of the operation. They are in charge of safeguarding a company’s assets and ensuring that the company’s profits and losses are in line with market conditions. Tailor internal controls that are appropriate for the type of business, its size and complexity, the regulatory environment in which it works, and the culture of the organization. They should be implemented by a competent individual or team, and they should be reviewed regularly to ensure they are still effective.

It is also necessary to keep track of internal control documentation to guarantee that internal controls are functioning properly.

Internal control documentation is the most valuable asset a business owner can have. Incorporated under this definition is the process of implementing internal controls, documenting internal control procedures, and preserving records of all transactions related to financial reporting.

As stated earlier, internal controls should be adjusted to the type of business, the size, and the complexity of the organization, as well as the regulatory environment in which it conducts its operations.

Policies and procedures for protecting assets from fraud or misappropriation by employees, customers, and business partners; preventing employee theft; monitoring cash receipts/payments against bank accounts from which funds can be withdrawn or deposited (to prevent embezzlement); ensuring compliance with laws, regulations, and company policy; and ensuring that internal control documentation is consistent with internal control procedures.

Background

If a business does not have proper controls in place, it puts itself in danger of being the victim of fraud. According to the Association of Certified Fraud Examiners (ACFE), fraud can be categorized into three major categories:

• Asset misappropriation,

• corruption, and

• Financial statement fraud

Despite this, many small firms and start-ups fail to recognise the critical need for having a well-functioning internal control system. The most frequently cited reasons for not implementing internal controls are that they are too expensive or that the company is too small and immature to do so.

Furthermore, because owners frequently compromise internal controls in the name of service delivery, internal controls suffer at smaller organisations and start-up companies.

However, businesses with fewer than 100 employees had a higher percentage of fraud charges than their larger counterparts, according to a survey conducted by the ACFE. The reason for this is that employees are usually in a better position to determine whether there is an optimal opportunity to steal from their employers. Even the most dedicated employees can find themselves in a tricky situation where stealing from their employer appears to be the easiest and most obvious solution. This comes from something known as the “fraud triangle”. We will talk about this later.

If you run a small firm or are starting one, you may be able to take on complete responsibility for internal control, which is a typical solution to control issues. Even though this is commendable, it will conflict with other tasks at the company and may rapidly result in burnout if done regularly.

Regardless, the owner will be unable to capture everything if an appropriate mechanism is not in place to capture it. Developing a reliable control system, rather than relying just on an individual, should be given more priority than anything else.

What is internal control?

In a business, internal controls are processes or procedures that are used to preserve the assets of the company and ensure that financial information is accurate. They can aid in the prevention of fraud and other forms of misconduct that can harm a company’s long-term profitability.

Internal control refers to any method, procedure, or practice that is used to help ensure the correctness of financial data and the protection of firm assets, such as accounting procedures. There are many different sorts of internal controls, ranging from spending monitoring to information verification against well-known sources. The implementation of effective internal controls can protect your company from losses while also making it more robust in the event of adversity.

There are 3 major types.

1. Preventive controls

2. Detective Controls

3. Corrective controls

Preventive controls

Preventive controls are used to keep fraud and irregular activities from happening. Small businesses must take preventative actions to protect their valuable assets. They are meant to prevent mistakes and fraud from occurring in the first place by identifying them in advance. Because internal controls can identify and fix risks before they become problems, they can help to lower the possibility of financial losses in the first place. When it comes to risk mitigation, small organisations can benefit from a range of internal control approaches. Organizations can avoid difficulties from occurring in the first place by adopting processes and procedures that are intended to ensure the quality and completeness of information, effective employee communication, and compliance with established rules and procedures.

Implementing controls that can prevent fraud or other misconduct from occurring in the first place, such as requiring employees to input information into a business computer system using passwords and personal identification numbers, can help reduce the likelihood of fraud or other misconduct occurring in the future (PINs). Thus, fraudsters are less likely to steal corporate assets by impersonating real employees because access is restricted based on their job responsibilities because of this practice.

Detective controls

Detective controls assist in identifying and correcting fraud or errors that were missed by the initial layer of defence. Some businesses do not have preventive controls in place, but they do have detective controls in place to discover when fraud or error has happened, among other things. Normally, this would not be considered a clever concept.

Financial statement audits, fraud detection and prevention programmes, and internal control reviews are examples of detective controls, although they are not the only ones available.

Accountability and accuracy of financial statements are crucial detective controls for small firms. Financial statement audits help to verify that the financial statements are correct and accurately reflect the genuine financial status of the company. Preventing fraudulent activity before it causes difficulties and protecting the company from losses caused by fraud are two important objectives of fraud detection and prevention programmes. Internal control assessments aid in the identification of flaws in internal control processes and the recommendation of corrective measures.

Corrective controls

Internal controls that are designed to correct the damage and put things back in their proper position because of fraud and error are known as corrective internal controls. This is frequently used as a final option.

Effective ways to establish internal controls in your small business

When it comes to internal controls, small firms may have some unique obstacles, but by implementing a few essential practices, fraud may be averted, and risk can be effectively controlled. Putting these simple procedures in place will go a long way toward protecting the organization from scammers. The following are a few low-cost yet effective measures you may put in place to help your company develop an effective internal control system (ICS).

1. Standard Policies and Procedures

To develop an efficient ICS, it is necessary to have a consistent policy and/or procedure for everything. In the absence of a clearly defined, repeatable method for accomplishing things, the risk of preventing or identifying fraud is negligible, especially if you are continuously “winging it.” Employees are quick to notice when things are done in a disorganized manner, and they can easily take advantage of this.

All employees, particularly those in top management, must be aware of and adhere to company policies and procedures.

Note that, even though rules and practices may still contain loopholes that allow dishonest employees to take advantage of them, they nonetheless provide a straightforward method of discovering when things are going (or have gone) wrong in the workplace.

2. Separation of duties

Duties that require oversight must be kept apart from one another. If the goods receiving officer is also in charge of vendor payments, they may simply fabricate phoney goods receipt paperwork and pay the supplier to benefit the supplier’s benefit rather than the company’s benefit.

To ensure that all duties are checked and evaluated by a different individual, the system was created. When people are aware that their performance will be subjected to an independent examination, they are less likely to engage in fraud.

Additionally, having the ability to conduct a transaction from beginning to end on one’s own is considered a poor technique for internal controls in most cases.

3. Access Controls

Establish limited access to important sections of the firm. Everyone should not have easy access to all sections of the firm. Employees should only be given access to information, documents, and places required for their job tasks.

4. Standardize Documents

It is necessary to develop one for all a company’s official papers, such as letterhead, invoices, receipts, and reports, to be consistent in their format. If there is no standard, there is a risk that the opportunity to combat fraud may be lost. For example, if your customer receives an unauthorized invoice from your business claiming payment, they may do so.

You should also serialise them so that you can keep track of which official document was used, when it was used, and for what purpose it was used.

When standardised documentation is employed, irregularities and inaccuracies may be more easily detected.

5. Management Oversight

Maintaining control over employees’ performance by requiring them to produce periodic reports for management review is a straightforward strategy for executing control. This could be accomplished using reconciliations and reporting.

Early detection of any inaccuracies and/or abnormalities that may be fraudulent is made possible by timely reconciliation and reporting of financial information.

6. Compulsory “vacations”

Given that they are continually “on the job,” numerous employees may be tempted to commit and conceal illegal conduct.

In the past, when someone else has taken over a role or position, it has been discovered that some fraudulent acts have occurred. Sending employees on mandatory time off frequently or to another department or function is an excellent approach for identifying fraud and errors.

The primary goal should be to keep the employees refreshed, but you never know what you might come across.

Conclusion

The importance of being aware of the possible hazards of internal fraud cannot be overstated for small business owners of any size. It is possible and does occur, regardless of the size of the organisation in question. A complete assessment of financial management should be conducted by every business owner to guarantee that they are not facilitating or disregarding the possibility of fraud occurring within their organization. The most effective way to accomplish this is to implement policies and procedures that reduce employee motivation to commit fraud while also ensuring that each transaction can be simply explained in a way that makes sense later.

In conclusion, it should not matter whether a company has one employee or ten thousand employees; internal control should be a crucial component of the organization that should not be taken for granted, especially if the assets of the organization are to be protected. Even though small organisations may lack the resources to completely implement an effective internal control system, they should make every effort to put procedures in place that are most successful in their work environments.

To receive assistance with internal control systems assessment or design for your firm, please contact our team.