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What Are 'Internal Controls'?

Internal Controls are a set of specific Standard Operating Procedures a business uses to collect accurate data, keep the business running smoothly, and to spot trouble. The better a company’s internal controls, the more reliable its financial reports, and the more confidence you can have in the quality of the company’s operations.

Josh Kaufman Explains 'Internal Controls'

One of the major benefits of tracking your financial and operations data over time is the ability to notice patterns in your revenue, costs, and Value Chain. Over time, these patterns become useful for budgeting, supervising operations, complying with laws and regulations, and preventing theft and fraud.

Internal Controls are a set of specific Standard Operating Procedures a business uses to collect accurate data, keep the business running smoothly, and to spot trouble as quickly as possible. The better a company’s internal controls, the more reliable its financial reports, and the more confidence you can have in the quality of the company’s operations. Internal Controls are most useful in four areas:

Budgeting is the act of estimating future costs and taking steps to ensure that these estimates aren’t exceeded without good reason. Budgets are very important in controlling Profit Margins, the Cash Flow Cycle, and Leverage. If part of your business breaks the budget in a given time period, you can take action to correct the situation.

Supervision is important in businesses that rely on employees or outside firms for important parts of its business process. By establishing controls related to delivery time, quality, cost, and systems failures, it’s possible to conduct evaluations and make changes in operations if necessary if standards appear to slip or performance targets aren’t met.

Compliance is necessary when a business operates in an industry affected by government regulations. The company may be obligated to collect and report certain data in the course of operations. Internal Controls ensure that this data is complete and accurate, preventing risks, significant losses, and potential legal issues.

Theft and Fraud Prevention is important to protect against the risk of financial loss by an unscrupulous party. Solid Internal Controls make it easier to notice something is amiss, identify the responsible party, and resolve the situation with a minimum of fuss.

In all of these areas, it’s useful to have a dispassionate third-party audit your data and control processes. Auditing is necessary to find and correct errors, particularly in large businesses with many moving parts. Auditing helps ensure the quality of the company’s data and can increase the confidence of lenders, investors, shareholders, and regulatory bodies regarding the business’ practices. In all cases, the auditing party should have no interest in the outcome: this “separation of concerns” helps ensure the results are accurate, particularly if they’re not pretty.

Financial controls also helps you to benchmark your company against other companies in your market. Every year, the Risk Management Association (RMA) compiles a huge amount of data from businesses in all industries. The RMA dataset makes it easier to discover what solvent businesses of various sizes spend on marketing, sales, operations, and capital in a given period of time.

Banks and investors rely on RMA data to determine whether or not a business their examining is typical. If the company’s costs are in line with revenues, outside parties are likely to assume the business has a lower risk profile. If the company is spending three times the typical amount on sales and marketing, it can be a signal of trouble, inefficiency, or shady accounting.

Industry groups can also be a useful source of data. Many markets have trade associations that collect and share information about successful businesses. By comparing your business’ data versus other companies in your market, you can get a better picture of how well you’re performing, and where your business could use improvement.

Questions About 'Internal Controls'

• Does your business have Internal Controls in place in these four areas?
• Do your controls need to be audited?

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"If something cannot go on forever, it will stop."

Herbert Stein, economist

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