“Garbage in, Garbage out…” These words never ring more true than when assessing the Internal Control strength, accuracy, and quality of the financial and operating reports of a business. The mistake I made in the early portion of my professional career in analyzing various financial and operating reports was to accept at face value the reports submitted for loan proposals. I would also add in the reviewed and audited financial reports released by certified public accountants. Granted, CPA based reports tend to have a higher level of integrity associated with the disclosure of a business’s operating results, but they are not full proof. In order to gain a fair and reasonable confidence in a business’s operating and financial results, a comprehensive understanding of the operating environment in which the business operates is needed.
Typically, before engaging auditing the financial reports of a business, CPAs conduct interviews and other fact finding exercises to learn the ‘how’ and ‘why’ of a business’s operations. When armed with this knowledge, then the audit engagement progresses. How should business owners and their staff approach Internal Control in a way that’s practical and valuable? Before answering this question, we must understand the ‘why’ of Internal Control for small to mid-sized businesses.
INTERNAL CONTROL FOR SMALL TO MID-SIZED BUSINESSES
Let’s keep it simple: Internal Control helps owners and their staff ensure business assets are kept safe from theft and lowers other operating risks such as obsolescence and waste. Also, from a financial analysis perspective, Internal Control keeps the business healthy in terms of strategic direction and cash position. In practice, Internal Control is a framework or model that ensures checks and balances on the workflow of a business’s operations to maintain and strengthen quality, increase productivity, and ensure efficiency. For example, from a staffing standpoint, how does one measure, review, and implement improvement strategies to maximize human capital productivity? Another example, per the strength of a business’s revenue model, how does one maintain control and ensure profitable margins on the business’s product and service mix? Trust me, there are so many other areas in which owners and their staff can implement and exercise Internal Control tools, but there is a balance here. In other words, control is great up to the point it begins to stifle innovation and hinder the free flow of operations and ultimately negatively impact earnings.
2 PRIMARY BUSINESS AREAS FOR INTERNAL CONTROL
For the sake of keeping the business environment innovative and free flowing, there are 2 primary business areas where one should implement various Internal Control tools: 1) Operations and 2) Financial Reporting. Concerning Operations, owners need to have control over the process workflow, output volume, and quality assurance of the business. Now, this doesn’t mean that owners become micro-managers, but it does mean they need to have access to information that gives them the data needed to make decisions preemptively rather than reactionary. Concerning Financial Reporting, owners need to ensure that the business’s operational activities are captured and recorded accurately for both internal and external reporting purposes. In both Operations and Financial Reporting, the most important component to ensure quality and accuracy is the integrity of the individual inputting the data and / or producing the reporting. A key way to assure compliance to the Internal Control model is to implement a rewards and recognition program in addition to a compensatory bonus structure for consistently high performance.
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