Internal controls. These are words often used by accountants. “You need better internal controls.”
But what does that really mean?
It means you must have policies and procedures in your business to help everything stay on track. They are meant to help make sure your accounting records are making sense and ensure there isn’t anything unusual going on.
Let’s look at some situations and see what could go wrong.
Say you live in a condominium. There is a guest suite available for people to rent. The superintendent is the person you contact to see if the guest suite is free on a particular night, and you complete a form to reserve the room.
The fee is $100 a night. The superintendent collects the fee from the person booking the suite and gives it to the bookkeeper weekly, to deposit in the condominium bank account.
Does that sound okay?
The $100 per night charge is much cheaper than any hotel room available in your area. You would expect the guest suite to be rented often.
You, being a resident in the condominium, receive the annual financial statements and are surprised to see how little money has been collected from renting out the guest suite.
What has happened here? The superintendent has been put in a bad position. They may be a wonderful person and you trust them and like them. You always chat when you meet in the hallway. But who is in charge of the guest suite? Who rents out the guest suite? Who collects the money? Who gives it to the bookkeeper?
Any questions about the amount of money collected from renting the guest suite place the superintendent in the spotlight. That person may have done nothing wrong, but they are the only person in most of the process. Sure, they hand off the money to the bookkeeper, but who says how much there should be there?
What could go wrong? The superintendent could rent the guest suite, but not keep the form, and perhaps intentionally (or unintentionally) pocket the money.
How do you fix this? You introduce internal controls - a process to protect the superintendent from potentially being blamed. It’s a process to make sure the money from renting the guest suite is always deposited.
Here are some possible internal controls:
- Someone else has access to the forms and booking dates. This would enable a count of the number of nights booked and could be compared to the total amount of money deposited.
- If the bookkeeper isn’t available, then the money should be given directly to someone else along with the forms. This means there are more people involved. More people means it is less likely things will go wrong.
Internal controls protect people from being blamed for something they may not have done.
Bookkeepers also talk about the integrity and reliability of the accounting records. If you don’t have financial statements you can rely on, then you won’t be able to make the right decisions.
Bookkeepers and accountants particularly like what is referred to as a paper trail. You can go back through an account and produce the information, either on paper or electronically, to support every number in your books. This gives you, the business owner, comfort too.
Here are a few examples of situations and what can go wrong:
- Your operations entail having goods delivered on a regular basis depending on your customers’ demand. The delivery person just drops off the shipment to whomever accepts it. What can go wrong?
- You have no idea if the goods being delivered are the ones you ordered.
- You don’t know if all the goods are in the shipment.
- You may end up paying for goods you never received or ordered.
How to fix this?
- Have the person who accepts the goods check the contents against the purchase order.
- The person then stamps or signs their name and date. They are then taking responsibility that the items listed are, in fact, delivered.
- The stamped purchase order then gets sent to the person responsible for paying the supplier.
- The goods go to the person responsible for restocking the inventory.
- The person in your business opens the mail and passes invoices along to the person responsible for paying them. They don’t stamp, or sign and date, any invoices that are received. Here’s what can go wrong if there is no stamping process:
- You can pay an invoice twice by mistake. This uses your cash needlessly and it can take a long time to sort this out with the supplier and get your money back.
- You can pay an invoice that isn’t a real invoice. By having one person stamp the invoice and another person pay it you have two sets of eyes ensuring you are paying for things you ordered.
- Your business has a requirement for two signatures on cheques. But you are going away for several days and there may be some bills that need to be paid. So, you sign a few blank cheques ahead of time. What can go wrong?
- The cheque can be used to pay for unauthorized purchases.
- The cheque can be stolen and the second signature forged. It is much harder to forge two signatures.
- It violates the purpose of having two signatures.
If you are a small business owner it may be that there is only one signing authority - you. So, since it is your money that is being spent you are likely to be careful about what you are paying for. But, as you grow, or if you have other partners, it is important to have two sets of eyes looking at expenses before they are paid.
- The person who is entering invoices into the accounting software program doesn’t write the account numbers on the invoice. Why is this bad?
- You don’t know if the invoice has been entered into the system. Account numbers make it easy to look up an invoice.
- You don’t know if it is in the right account. You can’t trace an invoice very easily if you don’t know where to look.
- Your employee went on a business trip and just submitted an expense report. There are no boarding passes for flights that were taken. Why is this a problem?
- There is no proof that the employee actually went on the trip. They may be able to provide anecdotes from the trip, but no indication that they went.
- They could have travelled using their own travel rewards for very less money and are charging you the full cost of the trip. They can pocket the difference.
- They could have driven to the destination instead. This is easier to do if the employee is including some vacation time in addition to the business trip. You pay for the more expensive flight.
How will Finazz help?
This software program flags line items that have changed from one period to the next. They may have gone up or down. But the point is there needs to be a logical explanation for why they have changed. You can’t possibly remember everything that happens in your business every day. That would be exhausting.
So, if there is an account that is flagged it needs to be investigated. But don’t worry, there is a button you can click to give you suggestions of what should be in that account, why things may have gone awry, and how to fix them. If expenses are not in the account that should be, you know they either haven’t been paid or they have been entered into the wrong account. Either scenario will likely cause more than one account to be flagged.
Diving deeper into the account will help you understand what was recorded and whether it was done correctly. Also, you can see if the paper trail is there.
This process means you will have better, more reliable information to make business decisions.
Are you ready to internal controls in place? Get started with our free checklist.