Why Internal Controls Are a Must for Small Businesses

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If you own or manage a small business, especially a start-up venture, it’s essential to have all your financial ducks in a row. You’ve probably gone to the trouble of setting up a budget and a timeline for business expansion. You may have targeted certain dates in the future to launch products or to go after further venture capital or loans. As you scale, transactions will trigger changes in your business environment. While change is good, the danger of going out there is on not keeping up with the changes.  Sometimes, the pain of not keeping up may result in financial losses. Internal controls put a halt to an uncontrolled faucet—it saves you resources, and most importantly, it refocuses your view on the things that matter. 

Therefore, one of the most important tasks you should take care of early on in the establishment of your business is the implementation of internal controls. 

Internal controls are policies and procedures designed to help you protect your assets, meet financial documentation requirements, and operate within compliance. Here is an introduction to internal controls and why they are a must for your small company, and the concept is not limited alone to listed companies. And here’s a nice bonus if you’re the business founder and CEO: you’ll get to take some tasks off your plate and free up your time to be the leader you’ve always dreamed of being. 

Spread the Work Burden

As the CEO and/or founder of a small business, you may find yourself wearing a lot of hats--too many hats most likely. It’s hard enough to get everything on your to-do list accomplished and even harder to do it to your high standards when you are constantly pressed for time. If you’re running payroll, balancing the checkbook, paying invoices, sending out bills, and conducting audits, you’re doing way too much in the financial sector of your company. 

Internal controls naturally help share the workload because an implicit tenet of internal control is the segregation of duties. Just like in many governments, separating tasks creates checks and balances and takes the pressure off the company’s leader and select top management. 

An example of segregating duties is having a different person reconcile your books than the one who is doing the spending. Another check is to require a second party to authorize spending over a certain threshold to ensure one person doesn’t get carried away with the checkbook. This way, you can have comfort that without micro-managing, all employees are oriented towards a control-conscious atmosphere, and delegation of authority becomes effective.

Make Policies Clear

Another natural result of initiating internal controls is that it forces businesses to write down their accounting and spending policies. When you take the time to do this, you can be more thoughtful about your finances. You can set spending limits, create a budget, and develop rules for documenting transactions. 

Having written policies can be helpful in multiple situations. For example, you may have an employee who does something unscrupulous that warrants reprimand or even dismissal. If you have clear-cut policies in place, there’s no question when someone violates them, and you can make enforcing the consequences unquestionable. You may even stave off a wrongful termination lawsuit. 

Furthermore, internal controls that are written down make it far easier to on-board new employees whose tasks may involve spending money, payroll, and the like. At some point, you will probably grow, and these early internal controls can be adapted for a new employee handbook to help train staff. You can even use some of these controls in employee performance and compensation reviews. The best part of it is that if you start head-on, your people are geared towards easily complying with internal control policies—something that emerging companies consider difficult achieving.

Provide Appropriate Documentation

Another way written policies can assist you is when you need documentation of your financial policies and budget, for whatever reason. Perhaps you need to undergo an audit, hire a tax professional, or apply for venture capital funding. In many instances, sloppy or missing record-keeping can hurt your business and result in penalties or a lost infusion of cash. Items you want to make sure to document include: 

  • Cash and banking transactions

  • Accounts payable and receivable

  • Spending budget

  • Payroll

  • Statements as required by law (taxes, nonprofit audits, etc.)

If you have gone a while with poor documentation, don’t despair. You can start where you are and make sure that moving forward, you’re providing better documentation. Once you get caught up, you can go back and reconstruct older records if needed. But don’t let a lack of documentation up until this point keep you from maintaining proper records in the future. Accurate information fixates your eyes to seeing what the real deal is, and not just some clutter of unnecessary data.

Aid in Evaluation and Forecasting

When you have internal controls in place in the form of budgets, financial policies, and written procedures, you will have a much easier time when it comes to evaluating your company’s progress with questions like: 

  • Are you sticking to your budget?

  • What is your burn rate?

  • How much cash remains on your runway?

  • Can you afford to take the next step in your business plan?

You’ll have the documentation you need to execute a thorough and accurate evaluation of your performance thus far. Once you can evaluate your current situation accurately, you can make much more precise plans for the future too. You’ll know if you have the reserves to scale up your business. You’ll be able to hire new staff or add product lines without hesitation, knowing you’re not in danger of financial stress. 

One thing many new small business owners forget to do is to create multiple sources of liquidity. Let’s say you have a sudden opportunity to do something or a need for emergency cash. You want to have several sources from which you can draw on the funds. When you set up internal controls, you’re more likely to think about scenarios like that. 

Prevent Fraud

You may not be aware that small businesses have the highest percentage of fraud and the highest median loss of all business types. You may not want to even imagine it, but sadly, there are employees--even coworkers in the upper management tier--who embezzle and otherwise commit fraudulent financial acts. This includes employees who engage in corruption by using their influence in the business for their own monetary betterment. 

When you set up internal controls for your business’s finances, you reduce the risk of fraud with the aforementioned checks and balances. In developing your policies and procedures, be sure to include protections like limiting data and password access and setting up fail-safes for vital financial roles and tasks. A simple example is to require two signatures on every check over a set amount. Other ways to prevent fraud with internal controls include: 

  • Conduct background checks and get references for prospecting employees.

  • Separate business and personal finances.

  • Check bank statements against business ledgers.

  • Track sales and other revenue sources.

  • Match outgoing expenses to invoices to avoid duplicate or overpayment.

  • Have a second person review payroll before it is distributed.

  • Minimize the use of credit cards.

  • Make sure employees are conducting financial transactions on work computers or devices.

  • Develop a strict bring-your-own-device program for the sharing of work data on non-company devices, including emails.

  • Mandate vacations to spot anything suspicious while employees are out of the office.

  • Use two parties or more when filing any insurance claims.

  • Conduct physical audits of inventory and cash on hand.

  • Calculate daily or weekly trial balances in between larger audits.

  • Use common sense if an employee seems to be living far beyond their means without any rational explanation (spouse’s income, inheritance, etc.).

  • Hire a knowledgeable board of directors who can help oversee the above and advise you on detailed elements of your internal controls.

Improve Your Business Terminology

Setting up internal controls for your company’s finances will help you get better at understanding business terminology you might have otherwise ignored. You’ll come across as more professional and experienced when it comes to the financial aspects of your startup when you understand terms like: 

  • Audit evidence

  • Control risk

  • Generally accepted accounting principles (GAAP)

  • Sampling

If all of the above sounds completely overwhelming and beyond the scope of your business, consider outsourcing your accounting and/or CFO roles to a professional team. Many successful small businesses do this because it accomplishes so much of the intention behind internal controls: 

  • Segregation of tasks

  • Work burden-sharing

  • Fraud reduction

  • Proper documentation

  • Better evaluation and forecasting

Do you want to scale your business? You cannot do that if you keep wearing all the hats, particularly in the financial department. You will never have the time you need to play with your creative instincts, pursue investors, or examine staffing needs. Be realistic--can you actually launch a new line of services while working 20 hours a week as your company’s ersatz accountant?

Scrubbed can take on many of your small business’s financial tasks and function in the role of CFO or accountant without you having to hire anyone. We can provide outsourced CFO services for a few months, a year, or more--however long it takes until you are ready for your own in-house employee. 

With turnkey business services that address virtually all of the concerns raised above, Scrubbed can help with: 

  • Accounting and financial reporting

  • Inventory management support

  • White label accounting

  • Audit and professional services

  • Tax preparation and filing

  • Corporate finance services

Scrubbed can also help you picture where you are at in terms of your controls consciousness and risk appetite, with the following:

  • Risk assessment and consultation

  • Gap analysis

  • Internal controls testing

  • Internal audit support

Contact Scrubbed today for a free consultation to see how your small business could implement the internal controls it needs by making use of our menu of services. We can help you stay on track to reach the goals that led you to open your business in the first place, and you’ll sleep better knowing you’re meeting requirements, setting checks and balances, and protecting the business assets you worked so hard to obtain. 



About The Author

 
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Matt has been heavily involved in integrated audits with Internal Controls Over Financial Reporting, risk consulting, and internal audit support. He supports clients' risk assessment process, evaluation of internal control, and provides control rationalization. His expertise also includes assurance and financial reporting advisory engagements. He champions millennial leadership and advocates controls consciousness of start-ups as requisite activity towards scaling.

https://www.linkedin.com/in/matthewgopez/