Importance of Internal Controls for Companies

Control Failures

Internal ControlsWhen reading about business failures, we usually focus on the firm or industry in question. You could do a search for the CEOs and other prominent people engaged, or you could keep track of the people who get caught in the crossfire of the media. However, we seldom try to learn more about what leads to such disastrous outcomes. Most scandals happen when there is insufficient oversight over vital procedures and operations.

Control failures are notoriously hard to spot without proper management and direction but have a devastating effect on value once they are uncovered. Managing the fallout also diverts attention from growth opportunities and managing the standard business operations. While there is no absolute certainty that a well-controlled environment can prevent fraud or a company from collapsing, it may greatly minimise the risk of such a catastrophe occurring. Internal controls can also enable continuous development by creating a more reliable and resilient operational structure.

Volatile Environment

The business, political, social, and economic climates of today are among the most volatile in history. Investors, regulators, governments, and society at large all have a vested interest in seeing improved corporate and financial governance practises. We’ve found that CEOs and boards aren’t happy until they see evidence that they’re prioritising a culture that values governance in a broader sense, rather than just relying on the results of limited internal audits. A system where controls are more than just a series of forms and checkboxes is necessary to enable rapid decision making while adequately protecting against risk. Having a well-defined risk appetite, continuously reviewed procedures and a well-understood, practically applicable control architecture are all necessary ingredients.

When the rate of change was linear and companies of all sizes had sufficient time to adapt to shifts in the commercial environment and markets, it was useful for them to look back on previous events and performances as a forecast of the future. The successful business of the future, however, will take a more proactive, even predictive, approach to bolstering its financial stability. In times of uncertainty, when risks emerge and the firm must detect them swiftly and respond boldly, a robust internal control environment is of paramount importance.

Risk Mitigation

A well-established system of internal controls may lessen risk while it optimises returns by laying a framework to enable expansion, which includes greater access to markets and capital, and it promotes financial resilience by providing openness, accountability, viability, and enhanced dependability and quality of financial information.

As a result of the ever-changing nature of the risks faced by businesses today, the finance department and the existing internal control environment are being pulled in different ways. A disjointed finance function and internal control environment increases risk since any change to a business model probably necessitates a matching adjustment to controls.

Value versus Cost

Value is driven by the fact that controls are in place to safeguard the firm now and make it more resilient in the future. All internal controls need to be risk-oriented and directed at the most vital parts of the business. Organisations with strong internal controls are more likely to provide timely, relevant, and accurate financial reports and to use those reports to make well-informed business choices that benefit all of their stakeholders.

It is essential to strike a balance between the benefits of a strong internal control system and the associated costs. In the event of financial mistake, cash leakage, or other repercussions of failing to develop a solid internal control environment, the cost might be far more than originally anticipated.

Preventative Controls

There are three basic sorts of internal controls: detective, preventative, and corrective. Preventive internal controls are implemented to, as its name suggests, avert an undesirable occurrence. Many programmes, for instance, contain built-in safeguards to prevent the entry of false information.

Preventive controls are superior to corrective controls because they reduce the need to identify errors after the fact. Even better are automated preventive controls since they eliminate the need for human involvement and streamline auditing. Training courses, drug testing, firewalls, and computer and server backups are all preventive internal controls that impede the occurrence of undesired events.

Separation of duties is a crucial internal control aimed to prevent the occurrence of errors or fraud by ensuring that no single employee has the ability to both commit and conceal errors or fraud in the course of their duties.  In general, the following responsibilities must be separated: Conducting transactions; Authorising transactions; Reconciliations; Creation of Control Systems; Review of Control Systems.

Keep in mind processes and control activities are imperfect; hence, errors and difficulties are inevitable. Consequently, a continuing examination and analysis of internal controls should be incorporated into the routine operations of any firm.

Advantages of Internal Controls

  • The ultimate responsibility for the control environment and the success of internal controls rests with management. The benefits of internal controls are contingent upon their proper implementation and continuous monitoring.
  • Internal controls function as an early warning system to discover concerns before they escalate into major difficulties. Quality inspections prevent the shipment of defective products to customers. A study into a decline in on-time delivery metrics may uncover an impending issue of greater magnitude. When problems are identified early, they are easier to resolve.
  • Strong internal controls discourage malfeasance among employees. When employees are able to identify process flaws, they may be tempted to commit tiny infractions that will eventually escalate to major ones. With several checks and balances, fraud is significantly more difficult to commit. Solid policies ensure that staff comprehend the repercussions.
  • Performing investigations and corrective measures based on the results of an external audit can be a laborious process. If an external audit identifies a severe process deficiency or material misstatements, you could lose your industry certifications or be subject to hefty fines. It is usually preferable to identify and resolve a problem before an external entity does so.
  • Strong internal controls can also shield you from expensive fines in the event that a data breach occurs. A regulatory body may lower penalties if an enquiry demonstrates that your firm behaved with due diligence and had proper controls.

We are here to help!

Do you need help reviewing your Internal Control procedures? Our auditors work with companies and organisations nationally across Australia to review and provide feedback on existing controls and suggestions from improving an organisations risk framework. Give us a call on 1300 157 712 or get in touch online and we will be in touch as soon as possible.