For any business to be successful in its operations, it must be efficient, reliable, and most importantly, secure. These three factors are especially crucial in the financial transactions of a business. You want your customers to trust you with their personal information and financial credentials. Your employees, senior management, and shareholders must also have the confidence that they’re safe when dealing with your firm.
This tells you of the importance of having internal controls in place. They are the means through which you can be sure that your company meets safety and efficiency standards. Unfortunately, many businesses fail to check the effectiveness of their internal controls, exposing themselves to various risks.
What are Internal Controls?
These controls refer to the mechanisms, procedures, and rules that businesses employ to protect their financial data and promote accountability. The procedures also help in fraud detection, which is crucial in the prevention of financial losses.
A report by ACFE, The Association of Certified Fraud Examiners, shows that businesses lose approximately 5% of their income to fraud annually. On a global scale, this translates to about $3.7 trillion.
The controls also enhance a company’s efficiency and ensure financial reporting is timely and accurate. Every business should implement data security controls to prevent data loss through cyber-attacks. If they’re well executed, the rules can identify any threats early enough and protect all business systems.
Identifying Internal Control Weaknesses
Unfortunately, these controls don’t always perform as expected. Sometimes they exhibit some weaknesses that compromise the business. Internal control weaknesses fall into four major categories, namely:
- Technical control weaknesses
- Administrative control weaknesses
- Operational control weaknesses
- Architectural control weaknesses
Weaknesses in the technical controls mainly have to do with hardware and software. They stem from the failure of software and hardware to perform efficiently. Operational control weaknesses arise from human error. Administrative control errors are due to limitations in the procedures and policies of the company. Architectural flaws refer to the inefficiency of a company’s IT environment and structure.
In identifying these internal control weaknesses, you should take the following steps.
List the Internal Control Procedures
The first most crucial step is to document all financial transactions, purchasing procedures, product design, and internal auditing. You need to know what you’re inspecting before you carry on with the process.
In this step, you need to gauge the parts of your organization that are more prone to risk than others. This step also entails assessing your controls’ design, including organization, documentation, segregation of duties, and training.
Conduct a Risk Assessment
A risk assessment for all the control procedures helps identify the most likely failures within the business or company. Risk assessments happen in the form of a table, with each new risk recorded in a row.
Analyzing the risk is a process that includes indicating everything that could go wrong and why. Record each risk factor in a different column, showing who is in charge of the process and the solutions.
Perform an Internal Audit
This calls for you to review your stock and asset inventories, accounts payable, and cash reconciliation. Cash reconciliation indicates a balance between the liquid cash the company owns and the income and expenditures.
An audit of the accounts payable entails checking that all payments are going to the right recipient. Ensure you cross-reference all these factors against all internal and external financial statements. Internal records are those in your accounts departments, while the external ones refer to bank records.
Train Your Employees
Employees should stay up to date with modern internal control processes. The mechanisms keep changing, just like other aspects of the business. As such, it’s essential to ensure your employees are aware of any changes and can keep up with them.
One of the factors contributing to internal control failures is a lack of knowledge and training. Evaluate how much your workers know and identify the training gaps to address during staff training.
Regular Inspections are Necessary
As mentioned earlier, some internal control failures arise from human errors. It’s, therefore, essential to regularly monitor your internal control employees. The process allows a third party to identify possible weaknesses that your employee or team may have missed.
The inspections can detect shortcomings in the process itself and the supervision of those in control. External auditing companies should perform this type of assessment. Make it your aim to establish a business relationship with a trusted external auditor.
Evaluate Customer Feedback
What your customers and other stakeholders say about your business can point to any existing internal control weaknesses. Be on the lookout for common complaints and any breaches in the internal control systems. For example, several complaints about product failure could indicate a problem in company procedures.
Assess Departmental Reports
It’s a wise idea to regularly check the areas of your company that are not performing as expected. Although the issues could be due to several other factors, it could also point to some internal control failure. Each department should control and monitor its operations, but the integrated reports should reflect the business as a whole. Ensure each department has a mechanism robust enough to identify and report these internal control weaknesses
Final Thoughts
Smooth, efficient, and safe business operations rely on the effectiveness of the internal controls in place. When the rules are weak and vulnerable to attack, your business, employees, customers, and stakeholders are at risk. As such, ensure you conduct regular internal control audits to identify weaknesses and fix them.
