Internal controls are critical processes and policies that help small businesses secure their systems and data. While often associated with large companies, small businesses have every reason to implement these controls. Statistics show that 28% of small businesses experience fraud, compared to 22-26% of larger companies. As fraud continues to rise, small businesses stand to gain significantly by integrating internal controls into their operations.
Why Do Small Businesses Need Internal Controls?
Small businesses need internal controls because they have valuable assets and information to protect. Larger corporations may have more resources to invest in cybersecurity and financial diligence, but small businesses can suffer significant losses from breaches and fraud. On average, fraud costs small businesses $150,000, a sum that many cannot afford to lose.
Effective internal controls can help small businesses:
- Reduce theft and fraud
- Avoid financial losses
- Build customer trust
- Securely grow the business
- Prevent liabilities
Key Internal Controls for Small Businesses
To safeguard their operations, small businesses should implement the following internal controls:
1. Separate Financial Duties
Assigning different financial responsibilities to various employees can reduce errors and theft. For example, one person can handle payments while another reconciles accounts.
2. Separate Bank Accounts
Maintaining distinct accounts for personal and business finances helps prevent the misappropriation of business assets.
3. Require Background Checks
Conducting background checks on new hires ensures they are trustworthy and do not have a history of theft, fraud, or embezzlement.
4. Regularly Inspect Inventory
Regular inventory inspections help account for lost or stolen items and verify that all orders are accurately fulfilled.
5. Implement Access Controls
Granting individual log-in credentials to employees ensures that only authorized users can access systems and data.
6. Restrict Access to Financial Systems and Data
Only those who need access to financial data, such as bookkeepers, should have it. This reduces the risk of misappropriation.
7. Update Passwords Regularly
Regular password updates, ideally every 30 days, reduce the risk of unauthorized access.
8. Reconcile Transactions
Regularly checking transactions against bank accounts helps identify unauthorized activities.
9. Check Credit Card Statements
Thoroughly reviewing credit card statements can catch fraudulent charges and unauthorized purchases.
10. Compare Receipts
Matching receipts to transactions ensures that all recorded sales are legitimate.
11. Create a Vendor Approval Process
A multi-step vendor approval process ensures that payments are made only to genuine vendors.
12. List All Vendors
Maintaining a database of vendors helps verify invoices and prevent fraudulent payments.
13. Mark All Invoices
Marking paid invoices helps avoid duplicate payments.
14. Randomize Reviews
Conducting random audits of transactions and accounts can reveal unauthorized activity that might be hidden during regular reviews.
15. Use a Point-of-Sale System
A POS system manages transactions and controls register access, securing cash on hand.
16. Connect the Register to the POS
Ensuring that the register only opens with a POS signal makes it harder for employees to steal cash.
17. Document All Transactions
Keeping records of all transactions provides a complete financial picture and helps identify discrepancies.
18. Establish a Backup Record
Creating a backup of financial records ensures data integrity in case of system failures.
19. Count the Register Daily
Daily cash counts help identify discrepancies and potential theft early.
20. Assign Two Employees to Count Cash
Having two employees count cash reduces the risk of errors and intentional misreporting.
21. Limit Cash Access
Restricting access to cash to specific employees minimizes the risk of mishandling.
22. Secure Blank Checks
Storing blank checks in a safe and limiting access prevents unauthorized use.
23. Introduce a Check Signing Process
Requiring dual signatures for checks adds an extra layer of verification.
24. Use Manual Signatures
Requiring manual signatures on checks and documents reduces the risk of forgery.
25. Implement Expense Limits
Setting approval thresholds for expenses ensures oversight of significant purchases.
26. Monitor Expense Reimbursements
Implementing a reimbursement process ensures that only approved expenses are reimbursed.
27. Verify Reporting Accuracy
Regular reviews of financial reports ensure that all information is accurate and timely.
28. Conduct External Reviews
External audits by a certified public accountant (CPA) provide an unbiased evaluation of financial controls and compliance.
29. Implement Controls Technology
Using technology to manage internal controls can automate processes and adapt to the growth of the business.
Checklist for Implementing Internal Controls
To get started with internal controls, small businesses should:
- Identify key financial processes that need controls.
- Assign responsibilities to different employees.
- Implement access controls and regularly update passwords.
- Conduct regular and random audits of transactions and accounts.
- Use a point-of-sale system for transaction management.
- Establish a vendor approval process and maintain a vendor database.
- Document all transactions and keep backup records.
- Regularly inspect inventory and count cash.
- Conduct background checks on new hires.
- Seek external reviews from auditors or CPAs.
By implementing these internal controls, small businesses can protect their assets, reduce the risk of fraud, and build a secure foundation for growth.
