Have you ever imagined your body without your backbone and spine? Beyond being a bone in the body, they are the elements that provide coherence and support to the whole body, and that is what internal control processes are to your businesses.
Designing and implementing internal controls in your business is not optional; it is mandatory if you want to succeed, regardless of your business type and size. A lack of effective internal controls can cause financial loss, operational disruptions, and reputational damages.
However, it can be complex and challenging to design robust internal controls. To simplify it, we have compiled the top 5 factors to consider when designing an effective internal control process.
How To Design Effective Internal Control Processes
Typically, designing internal control processes is complex. To simplify the process, you have to stick to some essential guidelines. Let’s look at the top factors to consider when designing an internal control process to ensure it is effective and solid.
1. Relevance to Identified Risks
The controls should directly address the specific risks. For example, if the risk is the potential for unauthorized access to financial data, your controls can incorporate access controls, high-level encryption, and conducting regular security audits. To design controls specific to the identified risk, the nature of the control, the approach, and the type must be in alignment.
To consider the nature of internal controls, you must choose between manual and automated controls. To do that, check the complexity of the identified risk. If the risk requires human judgment, then manual controls can be necessary. If the risk is related to ensuring accuracy in high-volume transactions, either in sales, expenses, or inventory, automated control might be the best.
The next thing to consider is the control approach. The nature of the identified risk determines the control approach. Internal controls can either be preventive or detective. Preventive controls aim to stop the occurrence of irregularities and errors, such as system access, authorization requirements, segregation of duties, etc. Detective controls are used to correct issues after they have occurred, such as periodic audits, variance analysis, reconciliations, etc. For comprehensive internal control, combine both manual and automated control types.
2. Appropriateness to the Level/Magnitude of Identified Risks
The internal control processes must be proportionate to the level and magnitude of identified risks to maximize the mitigation strategy and avoid wasteful spending. Over-controlling low-risk areas can be inefficient and lead to the waste of resources while under-controlling high-risk areas can be dangerous.
For instance, a small, family-owned business might implement basic controls for inventory management. A large multinational corporation would require a sophisticated inventory control system with high-tech security measures. Also, a low-risk operational process might only need periodic reviews, while a high-risk financial transaction will require multiple levels of approval and reconciliation.
Always carry out a cost-benefit analysis when designing an internal cost process to ensure that the cost of implementing and maintaining controls is not above the potential impact of the risks
3. Frequency of Performance of Control Activities
The mitigation process must be executed at the appropriate intervals and frequencies to mitigate risks. To determine the right frequency for your control process, you must understand the triggers for control performance, the frequency of the identified risk occurring, and the timing.
Triggers for control performance refer to conditions or events that can initiate the need for a control activity. For instance, implementing a new system, such as a new ERP or CRM, will require a post-implementation review to measure its relevance to the company’s needs. Also, an increase in transaction volumes can trigger the need for frequent reconciliations and reviews. The reconciliation can be made daily to ensure all the transactions are well-checked, leaving no room for fraud and financial irregularities.
If the identified risk has a high probability of occurring, then daily controls can be implemented, while less frequent risk activities might need only monthly or quarterly controls. Additionally, the timing of control is important to maximize its effectiveness. For example, a review of bank reconciliations should occur after the month-end closing process.
4. Competence and Authority Level Required to Perform the Control
You might have the perfect control system in place and the perfect implementation method, but without the right people to handle it, the control’s effectiveness will be reduced significantly, and it will seem as if there is an issue when there is not.
Match the right people to control activities. Ensure the employees have the necessary skills, knowledge, and experience to perform their control responsibilities adequately. For instance, in financial controls, employees in charge must have accounting expertise and knowledge of financial reporting standards. In placed in charge of critical financial controls.,
Clearly state the roles and designations of the employees in charge of the control activities. This helps everyone to know what they ought to do. This ensures order, accountability, and transparency. For instance, approving large expenditures or high-level transactions can be assigned to senior management or senior finance personnel.
Additionally, segregate or separate duties appropriately to avoid conflict of interest and reduce the risk of errors and fraud. By separating duties, you enhance the integrity of your organizational control processes. For instance, the person recording transactions should not be the same person who authorizes them.
5. Criteria for Further Investigation
To ensure that internal controls are effective, you have to ensure that deviations are promptly addressed. To do that, you have to set clear criteria for when further investigation is warranted. This involves defining what constitutes a deviation and setting thresholds that trigger an investigation.
Clearly state the standards and benchmarks for control performance to determine what constitutes normal behavior. For example, a variance of less than 1% in financial reports may be considered normal, while anything above this threshold may be deemed a deviation.
Deviations can range from minor discrepancies to significant irregularities. Deviation can be qualitative or quantitative. Establish clear thresholds to prioritize investigations and allocate resources effectively. These thresholds should be based on financial impact, frequency of occurrence, or other relevant factors.
Final Words
At Mac Adebowale Professional Services, we understand that designing a robust internal control system can be complex and challenging. That’s why we have well-trained and experienced experts to guide you.
Contact Mac Adebowale Professional Services today at emails@macadebowale.com or macadebowaleadvisory@gmail.com, and let our experts help you design and implement the internal control systems your business needs to stay strong and secure.
