then you have to use them.
by ed mendlowitz
77 ways to wow!
what are internal controls? auditors widely use this term. it also appears multiple times in engagement letters for audits of businesses and not-for-profits, but i do not believe many outside of the accounting profession really know or understand what internal controls are. i will try to explain it here.
more: the ten financial controls that’ll make you a hero | rule #1: start with cash | the priorities were backward | how to read a financial statement | 77 thoughts about client needs
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internal controls refer to an organization’s system of deterrence, oversight, checks and balances. an illustration is where someone in a business writes and mails the checks to pay a bill. if this same person then receives the bank statement and performs the reconciliation of that account, there would not be any control or oversight on that person and whether the payment was proper and not misdirected. they are checking their own work. this is how many frauds occur.
another illustration is where merchandise is ordered by a person who also receives it, places it in inventory and authorizes the payment. there is no oversight of the products received, that they were actually placed in inventory or that the right material was ordered, or even received. adding a different person to the process anywhere along the way can provide a control to thwart any theft.
employee theft can occur at any point if temptation is blatantly put in front of otherwise honest people. not always, but occasionally. petty thefts of packages of coffee and office supplies, up to scrap metal, to inventory items like parts and finished products can be easily taken without adequate controls. it is hard to secure coffee and office supplies, but parts and inventory can be controlled with a protected location and perhaps a video camera recording activity in and out of the area.
salespeople can pad their expense accounts and time workers can find ways to punch in earlier than when they show up or later than when they quit for the day. simple controls can impede many of these stealth frauds such as with periodic but regular spot checks.
it is incumbent upon every manager of a business or not-for-profit organization to assure that the controls are adequate and appropriate for the organization. there is also an easy way to approach this. if you have an independent auditor, ask them to review with you every item on the internal control evaluation checklist they completed for their last review or audit of your system. if you do not have an independent auditor, email me and i’ll send you a standard internal control evaluation checklist you can start with.
what keeps businesspeople up at night
i have gone on many leads for new clients where i was told they are switching accountants because they believe they are paying “too much tax.” however, at most of these meetings we might spend a few minutes on taxes and then most of the time on them wondering whether their controls are good enough.
my conclusion from this, as well as from many conversations with clients, is that potential loose controls are a major cause of keeping someone awake at night. no one stays awake at night wondering if they are paying too much tax – a pending tax audit might, but not paying too much tax.
there are certainly many other reasons, but i want to address controls here.
businesses are organic and need minding. part of this is to have adequate controls that do not tempt personnel to steal and:
- provide methodology to get things done the right way at the right time by the right people.
- customer orders do not get mislaid.
- customer backlogs are managed and are for the right reasons.
- inventory doesn’t accumulate unwisely or unnecessarily.
- orders to suppliers are for the right things in the right quantities.
- operational data is provided timely.
- overhead is properly allocated and not excessive in space and cost.
- that the cash flows in the right direction.
being a businessperson is very difficult. aside from knowing how to make the product, manage the process and personnel and control the cash flow, they need to know how to lead and run a business. each separate function is essential for a successful business, but many times how well the overall business is managed is the determining factor of its continued existence. yet, many owners do not do this, claiming they are “too busy.” the old cliché is true – you need to work on your business, not in it! benjamin franklin said that the eye of the master earns more than both of his hands.
if you don’t want to stay awake at night, have procedures established that watch over and control each of the items in the bulleted points above. it all has to do with controls. each of the items mentioned can be controlled and transparently quantified with information provided regularly and timely so that it can be acted on as soon as a problem is detected.
that is control and this will:
- enable you to sleep better and
- provide time and comfort for you to work on your business!
controls work, but only if you work on getting the right controls and then using them.