Signposts of strong internal controls

Internal controls are a system of policies and procedures businesses put in place to protect assets and improve operating efficiency. Internal controls specify how companies direct, monitor and measure their resources. Moreover, they are your borrowers’ first line of defense against fraud.

Re-evaluating controls in a recession

There’s no time like the present to focus on internal controls. For many, the recession has slowed business operations. Borrowers can use the downtime to assess and enhance internal controls.

Unfortunately, recessions also entice some employees to commit fraud. For example, a CFO may feel pressured to achieve unrealistic performance goals. Or a part-time clerk may be living beyond his or her means. Strong internal controls not only detect fraud, but they also prevent employee dishonesty from beginning.

Covering all the bases

Lenders should be on the lookout for these three basic controls that differentiate strong internal control systems from weak ones:

  • Physical restrictions. Employees should have access to only those assets necessary to perform their jobs. Locks and alarms are examples of ways to protect valuable tangible assets, including petty cash, inventory and equipment. But intangible assets — such as customer lists, lease agreements, patents and financial data — also require protection. Passwords, access logs and appropriate legal paperwork help serve this purpose.
  • Account reconciliation. Management should confirm and analyze account balances on a regular basis. To illustrate, strong borrowers reconcile bank statements and count inventory on a regular basis.Interim financial reports, such as weekly operating scorecards and quarterly financial statements, also keep management informed. But reports are useful only if management finds time to analyze them and investigate anomalies. Supervisory review takes on many forms, including observation, test counts, inquiry and task replication.
  • Job descriptions. Another basic control is detailed job descriptions. Company policies also should call for job segregation, job duplication and mandatory vacations. For example, the person who receives customer payments should not also approve write-offs (job segregation). And two signatures should be required for checks above a prescribed dollar amount (job duplication).

Taking matters into your own hands

Sarbanes-Oxley requires auditors to attest to the effectiveness of their public clients’ internal control systems and report any material weaknesses. Although private companies aren’t bound by these requirements, every business benefits from reinforced controls. A financial professional can help private companies evaluate internal controls and remedy any apparent weaknesses.

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