4 Reasons why good internal control is key to your business success

When business is small many of the roles are done by the owner, one man show.  Internal control is not so important as all the function of the business is done by the owner from procurement, inventory, sales, pay the bill, receive the money etc.  However, as the company is getting bigger especially on corporate levels, many of the functions are divided and done by department, personnel and managed professionally. I will discuss 4 reasons why good internal control is key to your business success.

One of the mantras we all learn is separation of duty.  However, in many cases as the business grows, the CEOs or Business Owners are more concerned about getting the work done, so the work is more around a person and not business process and internal control minded. 

If internal control is not good, CEOs and Business Owners might experience:

  • The business is loosing money as expenses is bigger than revenue
  • Increasing revenue is not equal to more profits
  • Frustration

From my experience helping turnaround companies, many businesses lost money not because of lackluster sales but because of weak internal control. So let’s define what internal controls are.

What are internal controls?

Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability and prevent fraud. This is definition obtained from https://www.investopedia.com/terms/i/internalcontrols.asp

The fraud tree below summarizes possible fraud in a company:

Knowing and aware of the risk of fraud, a good and proper internal control can be designed to minimize the risk.  Therefore, design of good internal control is key.

To make internal control effective, it has to be embedded in day to day operation from end to end, from where the transaction started until it ended.

How do we obtain good internal control?

  1. Separation of duties ensures that no single individual is in a position to authorize, record, and be in custody of a financial transaction and the resulting asset. 
  2. Proper authorization of invoices and verification of expenses are internal controls.
  3. Check and recheck: 4 eyes principles.  Not one single person has the full authority, check and recheck has to be embedded in the internal control.
  4. Internal audit evaluates company internal control and checking on the compliance to the SOP established.  Internal audit as opposed to external audit is audit done by the personnel of the company

No two systems of internal controls are identical, but many core philosophies have become standard management practice. While internal controls can be expensive, properly implemented internal controls can help streamline operations and increase operational efficiency, in addition to preventing fraud.

Word of caution: All the good design of internal control can be circumvented through collusion.

Why good internal control is key to your business success?

Imagine that everyone in the company can take money whenever and in whatever amount they think fit.  There is no control how expenses are approved and paid.  Goods are purchased at above market price with any price difference is pocketed by whoever makes the purchase.

On the revenue side, the salesman reports the sales at lower price that it actually is.  He pockets the difference in price, basically acting as middle man at the company expense.  Pocket the profit without cost and capital to him.

You get the idea, if this continues on the company will not survive in the long term.

Therefore, good internal control is key to your business success.  Besides complying with laws and regulations, and preventing employees from stealing assets or committing fraud, here is 4 reasons why good internal control is key to your business success:  

Reason #1: Safeguard your assets = safeguard your resources

The right controls protect a business’ physical and financial assets from fraud, theft, and errors. Likewise, proper controls quickly identify errors and fraud if they occur. One of the most essential concepts related to internal controls (and specifically to safeguarding assets) is the segregation of duties (i.e., separating incompatible functions) because it prevents a single individual from requesting, authorizing, verifying, and/or recording business expenditures.

Reason #2: Increase efficiency

Organizations typically operate more effectively with processes and procedures in place. A strong internal control environment can foster efficiency through automation of manual controls, removing unnecessary or duplicative steps in a process, or combining certain functions in a cost-effective manner. Finally, when financial data is consistent and easily accessible, management receives timely and relevant information to verify that activities are in-line with business objectives.

Reason #3: Keep your company healthy

Good internal control prevents or minimizes fraud and control revenue and expenses.  The objective of any companies is making profits and thus internal control helps in keeping the revenue and have expenses in check leading to revenue  greater than expenses and thus generates profits.  With profits your company stays healthy and sustainable for the long term.

Reason #4: Ensuring reliable financial reporting

Owners and managers require accurate financial information to make informed decisions. Because solid internal controls help to maintain the validity of financial data, they also equip management to make more educated judgment calls.  With proper internal control, the numbers reflected in financial reporting is more accurate and the timeliness is more assured.

In conclusion, without profits, business is not sustainable.  Therefore, without good internal control to safeguard your assets, to keep your cost less than revenue, any businesses will not be successful and sustainable for the long term.

Summary

Good well design internal control is key to your business success.  Without good internal control, many businesses loose money and could end up in bankruptcy.  Internal control is the mechanism to ensure integrity and prevent fraud.

Good internal control can be obtained by:

  • Separation of duties
  • Proper authorization
  • Check and recheck
  • Internal Audit

Why good internal control is key to your business success?

Reason #1: Safeguard your assets = safeguard your resources

Reason #2: Increase efficiency

Reason #3: Keep your company healthy

Reason #4: Ensuring reliable financial reporting

Good internal control is key to your business success to keep the difference between revenue and expenses to generate profits.  Profits is what makes a business healthy and sustainable for the long term.  Take care of your internal control design and you will reap the benefit for the long term.

Wish you success,

Ronawati Wongso

CEO & Founder

Rantai Breakthrough Consulting

Profit Optimization | Turnaround

Internal Control FAQ

What are internal controls?

Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability and prevent fraud.

How do we obtain good internal control?

1. Separation of duties ensures that no single individual is in a position to authorize, record, and be in custody of a financial transaction and the resulting asset. 
2. Proper authorization of invoices and verification of expenses are internal controls.
3. Check and recheck: 4 eyes principles.  Not one single person has the full authority, check and recheck has to be embedded in the internal control.
4. Internal audit evaluates company internal control and checking on the compliance to the SOP established.  Internal audit as opposed to external audit is audit done by the personnel of the company

Why good internal control is key to your business success?

Reason #1: Safeguard your assets = safeguard your resources
Reason #2: Increase efficiency
Reason #3: Keep your company healthy
Reason #4: Ensuring reliable financial reporting