Understanding the Basics of Internal Controls and Its Best Practices
Key takeaways
- Internal controls in accounting are methods and procedures for auditing a company’s financial processes.
- With corporate governance, the security of financial reporting and audit trails became compulsory. Moreover, this also made sure to define accountability.
- Internal audits are crucial in assessing the internal control of an organization, that will simultaneously take care of corporate governance and the accounting functions.
- The key components of the internal control framework are control environment, risk assessment, monitoring and reviewing, information and communication, and control activities.
- Cflow’s simple user interface and no-code workflow generation make internal control automation a seamless endeavor.
What Are Internal Controls?
Internal control in accounting and finance is an essential process. So, what is internal control? Internal controls in accounting are methods and procedures for auditing a company’s financial processes. The auditing process of the finance department is an important aspect of any business to ensure the security and integrity of the financial handling and compliance. Internal controls are one of the standardized ways to stay compliant with rules and regulations, making it easier for companies to secure their business from any fraudulent activities.
Table of Contents
Internal controls gained prominence as a key business process with the Sarbanes-Oxley Act 2002, enacted to ensure the safety of investors from fraudulent accounting undertakings. With corporate governance, the security of financial reporting and audit trails became compulsory. Moreover, this also made sure to define accountability.
The major goals achieved through internal control in an organization are –
- Safeguarding assets – Internal controls are responsible for maintaining and safeguarding the assets from any fraud or accident.
- Ensure the reliability and integrity of financial data – Audits through internal controls ensure that the financial data and records are accurate and complete.
- Ensure compliance – With several laws and regulations in place, internal controls ensure that every activity complies with these regulations, not affecting the business.
- Promote efficiency and effective operations – With a standardized procedure to audit finance and accounting, the efficiency and effectiveness of complete business operations improve.
- Accomplishment of goals and objectives – A management system like internal control enables the employees to achieve accounting goals and objectives more efficiently.
What is the Purpose of Internal Controls?
Internal audits are crucial in assessing the internal control of an organization, that will simultaneously take care of corporate governance and the accounting functions. These processes regulate the company’s alignment with policies and its security in handling sensitive data. This is why having robust internal controls. It develops a management where IT security, protocols, and systems are safeguarded. The important benefits include –
- Improved business efficiency
- Negating risks and fraud
- Cost-cutting on external audit companies
- Better control of financial dealings
Know the Advantages and Disadvantages of Internal Controls
Advantages
Finance and accounting cannot be left unaudited due to the risks that are associated with it. Hence, an internal control audit will give businesses an upper hand in controlling unexpected situations. Here are some of the advantages of internal controls.
- Detection of Errors and Frauds
The primary need for control measures is to secure financial activities by timely detecting errors and frauds. This is done by segregating the work among employees, delegating control over the process, and not burdening them. For instance, if one employee is in charge of recording the transactions, another employee can be responsible for generating financial statements. This way, any errors or fraud can be easily detected.
- Time Efficiency
Systematized internal control methods record all financial transactions clearly and accurately. This way the auditing process can be performed faster, saving time and other resources. Tasks are completed in the stipulated time frame.
- Operational Efficiency
As the processes remain efficient and error-free, employee performance is enhanced simultaneously. With such a system in place, inconsistency, fraud, and data misuse are reduced, and defined accountability and reliability are established with all operations.
Disadvantages
Internal controls can be beneficial on many fronts, however the implementation can be weighed down by certain limitations. Here are some of the common disadvantages of internal controls.
- Collusion
Collusion can be a common limitation when it comes to safeguarding your finances. Even though companies segregate the tasks, focusing on preventing any issues, there is a high chance of employees committing collusion in the shade of complex processes.
- Human Error
Human judgment and bias can impact the process, creating chances for errors and inaccuracies. Manual entries and recording can cause minor mistakes which can go unnoticed.
- Unforeseen Circumstances
Internal controls can detect and navigate certain ambiguities and hazards to some extent. However, not all circumstances can be foreseen all the time. The cost that has to be put in to control the situation will outweigh the benefits. Such situations can take a toll on the operational efficiency of the accounting and financing departments.
Structural Framework of Internal Controls
The internal control accounting framework entails the way accounting and internal control must be implemented in a business organization. This specifically details how these functions are integrated into the existing business processes. The framework of internal controls in accounting is made of the following five components –
Control Environment
The control environment sets a tone by defining the importance of security and integrity.
Such a space allows employees to be committed to identifying the inefficiencies and risks at the right time. The upper management and employees set the control environment and are given clear directions to practice it. The major factors of the control environment include –
- Ethical values and integrity
- Organizational culture and philosophical values
- The method of work and responsibility delegation
- The direction provides by the company
Risk Assessment
Regular risk assessments are a compulsory part of internal control which has to be carried out to keep a watch on any possible financial risk or loss. Based on the results obtained from the assessment enable the team to determine the area of focus and take preventive measures.
Monitor and Reviewing
The complete system of internal control must be monitored and reviewed periodically. Doing so ensures that the auditing tasks become ancient. As time evolves, the internal control policies and procedures have to be enhanced and updated.
Information and Communication
Information and communication management is crucial in practicing internal control. The employees must clearly be communicated their roles and responsibilities regarding the information available and how to work with them.
Control Activities
Internal control actions are the steps and methods followed to mitigate any risk factor in accounting and finance. These control activities are of two types – preventative and detective – and will be discussed in detail in the next section.
Apart from the five major core components mentioned above, the following are other parameters that complete the framework.
Compliance with Laws and Regulations
Compliance is essential for businesses. Every activity has to be compliant with certain standards and policies. Businesses that follow this can adapt to new changes easily.
Separation of Duties
The delegation of tasks and responsibilities is yet another crucial step. This detection of causes of errors becomes easy. The accountable employee can also be identified.
Physical Controls
Physical controls emphasize the security of business assets such as inventory, cash, equipment, etc. The security measures for these assets might include storage, access control, surveillance systems, etc.
The Two Types of Internal Controls
As mentioned earlier, the internal control activities can be broadly classified into two broad categories –
- Preventative controls
- Detective controls
These control activities include different tasks such as authorizing, documenting, reconciling, security, and delegating tasks.
Preventative Controls
As the name suggests, this set of activities aims to prevent any form of fraud and errors from happening in the first place. Based on the concept of delegation of tasks, the activities that are included in the preventative controls are authorization and documentation. Additionally, the segregation of tasks also ensures that not one person is in charge of handling, authorizing, and recording everything.
The examples include –
- Task delegation
- Pre-approvals
- Access control
- Physical control of assets
- Employee screening and training
Detective Controls
The detective controls activities are designed to detect issues or errors that have happened after the transaction. The important point to note is that detective controls stand as evidence of whether preventive controls are working as expected, as well as an additional level of security method. Hence, detective controls are considered as the backup procedure.
- Monthly auditing of transactions
- Performance review
- Physical inventories
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Best Practices in Internal Control
- Establish effective communication channels with reminders on policies and process flows.
- Conduct regular risk assessments which will help in being prepared to tackle issues that arise.
- Ensure every employee is aware and familiarized with the control policies to make the management better.
Secure Internal Controls Accounting with Cflow
Cflow is an AI-based workflow automation platform that can effectively ensure the safety of the finance and accounting of your business. Catering to small and enterprise organizations, our no-code platform is a prime example of efficiency with security. Users can automate the financial process end-to-end and define access control and accountability. This ensures the data, assets, and resources remain safeguarded.
Key features of Cflow include –
- Customizable Workflow Templates – With customizable workflow templates users can save time to create workflows from scratch.
- Integration – The platform supports API integration making the process flow smooth.
- Security and Encryption – The tool promises the highest security to data and encryption which in turn is controlled by the user.
- Flexibility – Cflow offers flexible approvals, making business processes simple and easy.
- Reports and Analytics – Deep insights regarding all the processes can be obtained through reports and analytics.
- Rules Engine – The sophisticated rules engine helps in navigating the tasks to the right team members at the right time.
- Document Management – With features like OCR, Kanban, and Fuzzy Search, documents can be managed easily for the completion of different tasks.
Case Study – CapEx Automation for SnF Management Company with Cflow
Overview
SnF Management Company is a worldwide known business for its service of professional and skilled nursing and rehabilitation centers under the name Windsor. The company handled a great deal of CapEx projects and required a fast-paced approval process, in the absence of which, the process remained slow and caused delays.
Challenge
The CapEx projects and their approvals were handled manually, which led to delayed processing. The manual setup also lacked visibility into the status of each request, which left the requesters with no status updates. To eliminate this scenario, the SnF Management Company was searching for solutions to speed up the CapEx process.
Solution
With extensive research on automation solutions, the company finally landed on Cflow for optimizing its process. As a no-node workflow automation platform, Cflow was able to streamline the different tasks within CapEx by setting up a CapEx Approval workflow that transformed its pace. The process automation also enhanced customer support.
Outcome
SnF Management Company was able to eliminate inefficiencies in the CapEx process with the powerful automation support provided by Cflow. Approvals that were delayed are now processed at the right time. Cflow helped in improving the transparency of the process as well.
Final Words
Accounting and finance is a key function in any business. The better the stability of it the better the business profits. As several risk factors influence the process, it is highly necessary to track and review your financial practices. This is where internal controls gain prominence. So the question is, how well companies can handle internal controls manually?
Cflow is an established platform for this purpose. The workflow automation tool can automate internal controls through rule-based workflows, making it more efficient, transparent, reliable, and error-free. Sign up on Cflow now for a free trial.
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