What are internal controls?
Investopedia.com defines internal controls as “the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.” [1] In other words, internal control is systems put into place to help protect businesses.
Internal controls include approvals, reconciliations, and segregation of duties. Having checks and balances in place for your business operations creates a lower risk of fraud, including theft.
Why are internal controls important?
It’s shocking how often businesses are affected by fraud. According to business.org, “22% of small-business owners have had employees steal from them.” [2] This indicates that, unfortunately, many small businesses provide their employees with opportunities for theft. The best way to help prevent these types of opportunities is through internal controls.
Internal Controls for Small Businesses
Implementing internal controls, most assume, requires a significant number of resources, including time, money, and personnel. This is only sometimes the case, and there are ways to improve internal controls without a considerable time or dollar investment. One of the main methods of internal controls is the segregation of duties, meaning dividing up the processing portion from the approval. Compared to larger companies, small businesses often have many processes handled by few people. It’s the old saying of “wearing many hats.” You don’t want that old saying to create an environment where certain employees have access or unilateral authority without any oversight or review.
When creating additional segregation and increased approvals, using the already established people on staff or consultants can be seen as a benefit to not only the employer but to the employee.
It creates opportunities for those employees wanting to expand their skill set, knowledge, and visibility within the company. Depending on the business size, people from separate departments or having different job duties would need to be utilized to ensure the checks and balances are established and maintained. This is also a benefit to increase team collaboration and communication.
Ways to Implement
The easiest and virtually no-cost way to implement internal controls is through approvals. Approvals can be added to every aspect of the business cycle, but for small companies, we’ll focus on two – accounts payable payments and payroll.
Accounts Payable payments should include multiple authorizations. There should be an approval for the initial purchase of goods or services. An example would be requiring a purchase order for all purchases over a certain dollar amount. The purchase order would then need to be matched with the vendor invoice. The second approval would come when the payment is made to the vendor. It is recommended that all payments be made electronically, but the approval process should be the same as paper checks. The only person making payments should be an authorized bank signer. If paper checks are still used, they should be signed by the bank signer. Stamps or printed signatures should not be used. Blank checks should never be signed, and unsigned blank checks should be stored in a locked area that only some people can access.
Payroll approvals are vital as payroll fraud is the number one source of employee theft and is an even more prevalent problem for small businesses. All payrolls should be reviewed and approved by an individual with bank signing authority, which is different from the person who processed the payroll. There should also be an established procedure for pay increases, bonus payouts, and expense reimbursements. Another review can be done regularly to ensure all employees take their paid time off. Establishing requirements and enforcing that employees take their paid time off is the best defense against fraud that occurs when employees are stealing and would be caught if another employee had to cover that process in their absence.
Another way to implement internal controls is to have the right technology.
There are my affordable options, but ones many small businesses should consider are accounting software like QuickBooks Online, inventory management systems, and point of sale (POS) systems. Technology offers limiting access, providing approval methods, and creating a transaction audit trail. In most cases, these systems also streamline business operations by increasing efficiency, so two benefits for the price of one.
Liquid Assets are the One Most at Risk
Often, theft occurs with the most liquid assets, such as cash and inventory.
There are many ways to safeguard cash. First, it is imperative to reconcile all bank accounts at a minimum monthly, including petty cash or any cash on hand. A different person should do bank reconciliations than the person signing the checks; this is another example of the segregation of duties. Cash drawers should be counted and reconciled daily, removing the deposit and leaving the same dollar in the drawer daily (typically around $200-$300).
If possible, deposits should be made daily. The overall best policy is to have very little cash on hand, and any cash on hand should be stored in a locked area that few can access.
Inventory is another asset where procedures can be implemented to reduce the opportunities for fraud. Inventory must be counted on a very regular basis, monthly is suggested if variances found are within an acceptable level. The frequency of counts should increase until the variances are within tolerable limits and can be explained or traced back. All inventory should be counted, including merchandise inventory that may or may not be tracked for accounting purposes. Having all inventory counted shows employees that inventory levels are being monitored and theft will be caught.
Inventory counts should be completed with two people but separate and independent of each other. It’s best to have the counts done on blank count sheets (inventory SKUs listed with no quantities provided). Suppose there are differences between the counts; a separate count of that SKU or SKUs is done to ensure which count is correct.
In addition to physical counts and reconciliations, having locks on all inventory storage locations is highly recommended.
Lastly, all inventory movement should require documentation, including a second level of approval.
Let Protea Financial Help You with Your Internal Controls
Are you looking for more information? Contact Protea Financial today and let us help you improve your internal controls by providing services, including inventory and account reconciliations, on a timely, reliable basis so that you can focus your efforts on maintaining and growing your business.
[2] https://www.business.org/finance/inventory-management/best-inventory-management-software/
