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Advice & Best Practice

How to create a robust internal control system for your business

Internal controls safeguard assets, ensure accurate and reliable financial reporting, promote compliance with laws and regulations, and help achieve operational objectives

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Creating a robust internal control system is essential for ensuring the integrity and efficiency of your business operations. Here’s a comprehensive guide on how to develop a strong internal control system:

Understand the components of internal control

The foundation of an effective internal control system lies in understanding its key components as outlined by the UK Code, which is quite similar to the Committee of Sponsoring Organisations of the Treadway Commission (COSO) framework in the US. These components include the control environment, risk assessment, control activities, information and communication, and monitoring activities. 

The control environment sets the tone at the top and encompasses the integrity, ethical values, and competence of the company’s people. Risk assessment involves identifying and analysing relevant risks to achieving the entity’s objectives, forming a basis for determining how the risks should be managed. Control activities are the policies and procedures put in place to mitigate risks, including approvals, authorisations, verifications, reconciliations, and reviews of operating performance. Information and communication ensure that pertinent information is identified, captured, and communicated in a form and timeframe that enables people to carry out their responsibilities. Monitoring activities involve conducting ongoing and separate evaluations to ascertain whether each component of internal control is present and functioning.

Establish a strong control environment

A strong control environment is fundamental to an effective internal control system. Leadership commitment is crucial; senior management and the board of directors must demonstrate a commitment to integrity and ethical values. This sets a positive tone for the entire organisation and fosters a culture of accountability and transparency. 

Defining a clear organisational structure with distinct lines of authority, responsibility, and accountability ensures that all employees understand their roles and responsibilities. Additionally, hiring competent personnel and providing ongoing training to ensure they have the necessary skills to perform their jobs effectively is vital for maintaining a robust control environment.

Conduct a thorough risk assessment

Conducting a thorough risk assessment is a critical step in developing a robust internal control system. Begin by identifying all potential risks that could affect the achievement of your business objectives, considering both internal and external factors. Then, analyse the likelihood and impact of each risk to prioritise them and determine where to focus control efforts. Develop appropriate responses to address each risk, which may involve accepting, avoiding, transferring, or mitigating the risk. A comprehensive risk assessment provides a solid foundation for implementing effective control activities.

Design and implement control activities

Designing and implementing control activities is essential for mitigating identified risks. Preventive controls are measures put in place to prevent errors and fraud before they occur. Examples include segregation of duties, authorisation of transactions, and physical security of assets. 

Detective controls are established to detect errors and fraud after they have occurred, such as reconciliations, audits, and reviews. Corrective controls involve procedures to correct identified issues, which may include adjusting processes, retraining employees, or implementing new controls. Together, these control activities form a comprehensive system that addresses risks at multiple levels.

Ensure effective information and communication

Effective information and communication are critical components of a robust internal control system. Develop and maintain information systems that provide timely and accurate information to manage the business effectively. Establish open lines of communication within the organisation to ensure that important information flows freely. This includes upward, downward, and lateral communication. 

Thorough documentation of control processes and procedures is also essential, providing a reference for employees and auditors and ensuring consistency and transparency in control activities.

Monitor and evaluate controls

Monitoring and evaluating controls is necessary to ensure their continued effectiveness. Integrate monitoring activities into routine operations, such as regular management reviews and supervision, to continuously assess the performance of the control system. Conduct periodic evaluations, such as internal audits, to provide an independent assessment of the control system’s effectiveness. Establish a process for reporting control deficiencies to appropriate personnel and ensure that corrective actions are taken promptly. Continuous monitoring and evaluation help identify areas for improvement and ensure that the control system adapts to changing business environments.

Continuously Improve the Internal Control System

A robust internal control system is not a one-time effort but an ongoing process of assessment, improvement, and adaptation. Use feedback from monitoring activities to make continuous improvements to the internal control system. Stay current with changes in laws, regulations, and best practices that may impact your control system. Regularly train employees on the importance of internal controls and how to effectively implement them. By fostering a culture of continuous improvement, businesses can maintain a strong internal control system that enhances operational efficiency, ensures compliance, and protects assets.

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