What Are Internal Controls & Why Are They Neccessary?

Let us take a brief look at internal controls in general. "Internal control comprises the plan of organization and all of the coordinate methods adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency, and encourage adherence to prescribed managerial policies" (State University, 2008, para. 1).

More specifically, these controls can be broken down into two specific categories, depending on their basic purpose. The first group, preventative controls, is comprised of any safeguards set up within a company that to try to avoid errors and other irregularities in the organization's financial records. The second category, detective controls, though, are any measures utilized to find any irregularities/errors that have managed to sneak through the first type of controls (preventative) (State University, 2008).

Dangers of Putting Off Developing Internal Controls

Some business owners (or other high-ranking personnel) may put off developing and/or setting up appropriate internal controls for their own companies, dreading the time and effort it can take to safeguard a business's financial records. But perhaps they would immediately change their minds if they considered the consequences of not having internal controls. Internal controls are used to reduce how much access and power each individual person has inside an organization. These controls try to divide the various types of business tasks among as many different people as possible, so there is always at least one other person able to monitor each employee's actions, reducing the likelihood of mishaps or underhanded behavior (Gelb, 2008). If accounting irregularities (regardless of whether they are intentional or accidental), remain undetected, they could mean financial disaster or even financial ruin to a company, particularly small businesses like your home inspection company. Internal theft alone costs American companies billions of dollars each year. And extremely often, too many of these hapless companies are hit so hard that they can never recover and thus are forced to close their doors (Zimmerman, 1989). In the end, since smaller businesses tend to have a lot fewer resources, unchecked errors/irregularities could be easily disastrous.

Tips for Developing Internal Controls

Consequently, every business owner should begin planning internal controls for his or her business as soon as possible, so there will be adequate controls enacted by the time employees are hired. The following are some helpful tips for developing internal controls for your own business:

Not all internal controls are possible and/or appropriate for every size of business. Therefore, you need to take the small size of your company into account when you develop your internal control plan. If you are a small business owner you must realize that you will have to play a larger role in controlling your business than an owner of a larger company would have to do. Less employees requires more tasks per person and thus makes it a challenge to ensure that each employee does not have too much access or power in one area of your company (Kulzick, 2001; Zimmerman, 1989).

Also, you will need to keep in mind what the weak points might be in your company to develop internal controls that will specifically address these problem areas (Zimmerman, 1989).

Finally, you must not forget to reassess your internal controls periodically to ensure they are adequate enough to safeguard all of your company's weak points and continue to be that way as your business continues to grow. Ultimately, as the face of your business changes, you will need to reinvent your internal controls to account for these changes (Zimmerman, 1989).

Examples of Internal Controls

Financial Records. Two good examples of internals control that would help you limit your employees' access to financial records is (1) requiring all computers that contain critical records to use a password known only to you and (2) keeping copies of these records in a secure location away from the business site. This will make it difficult for one of your employees to commit fraud or cover up unethical behavior (Kulzick, 2001).

Assets. Furthermore, it is always a good idea to safeguard your assets since they are vital to your company's survival. Oftentimes, cash proves to be a problem area for many businesses since cash can so easily disappear without a trace. As a result, you should consider using mainly checks during your day-to-day operations. This will allow you to track your regular expenditures and ensure your money is going exactly where it is supposed to go, not into the pockets of dishonest employees (Kulzick, 2001).

Cash Receipts. Likewise, you need to be watchful of all cash that is coming into your business, since it too can easily vanish. To control this critical area, you should split up the different duties required to handle cash receipts in your company. No single individual should be in charge of receiving, depositing, and recording cash payments since this creates prime opportunity for that employee to pocket some of the business revenue without anyone noticing (Kulzick, 2001).

References:

Gelb, E. P. (2008). Internal controls. Retrieved June 19, 2008, from http://www.smartbiz.com/article/articleview/270/1/5/

Kulzick, R. S. (2001). Internal controls can make or break your business. Retrieved June 19, 2008, from http://www.kulzick.com/intcont1.htm

State University of New York College at Brockport. (2008). What are internal controls? Retrieved June 19, 2008, from http://www.brockport.edu/intcontrol/definition.html

Zimmerman, K. (1989, July 1). Using internal controls to reduce employee theft in small businesses. Retrieved June 19, 2008, from http://www.allbusiness.com/human-resources/110071-1.html