13 reasons why internal controls are important
Internal controls are your first line of defense. Like washing your hands or locking your front door, they’re the processes that keep bad actors at bay. As a result, you cannot understate the importance of internal controls.
When implemented effectively, internal controls promote compliance with relevant regulations, secure company systems and data, and contribute to real-time reporting. However, these are only a few reasons why internal controls are important.
Here, we explain:
- The importance of internal controls
- Tools for streamlining internal controls management
The importance of internal controls
Internal controls are important because they protect an organization’s systems, data and assets. As significant as security is, the importance of strong internal controls is even further reaching than that.
An effective framework for internal controls can help organizations:
1. Mitigate risk
This is one of the most — if not the most — important things internal controls do. In fact, this is why internal controls exist: to put guardrails on business activities that keep the organization on track and ahead of risk. Without internal controls, organizations can’t assure regulators, investors or even the board that systems, data and financial statements are secure and accurate. All risk-reducing practices trace back to internal controls.
2. Implement processes
When internal controls are in place, employees know the processes and procedures they should follow. This strengthens the company because employees understand expectations and can securely engage with systems and data.
3. Optimize processes
Another reason why internal controls are important is that they can lead to process improvements. Controls apply a risk-based lens to all activities, empowering risk teams to hone in on processes that contribute to strategic objectives and mitigate risk. This ultimately leads to a more productive, more risk-aware company culture.
4. Boost efficiency
With internal controls, there’s only one right way to engage with any system, data set or repetitive process. That means employees only leverage their most efficient option rather than creating their own processes as they go. Automated internal controls can further streamline activities, leaving teams free to pursue more strategic work that directly contributes to company objectives.
5. Increase information accuracy
Data accuracy is critical for any organization. Without it, boards make decisions based on faulty information, leading to strategies that can do the business more harm than good. Internal controls are important because they offer guidelines for collecting, storing and reporting information. This creates systems for accurate, timely and reliable data for boards and investors alike.
6. Reduce fraud
A key tenet of internal controls is segregating duties, meaning the person undertaking an action isn’t also the person approving it. For example, an employee purchasing new laptops for the sales department shouldn’t be the same employee who approves the purchase order. This ensures that all actions are beneficial to the business and insulated from fraud.
7. Improve financial reporting
Financial statements can be challenging to produce if the organization’s transactions aren’t regularly available. Having controls around how and when employees should report transactions paves the way for more accurate financial statements, enabling leadership to make more informed decisions involving the company’s finances.
8. Identify errors
Mistakes happen. It’s all too easy to transpose digits or enter a figure on the wrong line. Internal controls like automation are important because they help organizations catch and fix those errors before they cause costly reputational damage.
9. Ensure regulatory compliance
Internal controls aren’t just nice to have; they’re a regulatory requirement. Regulations like the Sarbanes-Oxley Act require organizations to implement internal controls for financial reporting. Disclosures about these controls must also appear in the annual report. Organizations with internal controls can more easily prove their SOX compliance and show investors they utilize sound financial practices.
10. Avoid conflicts of interest
Separation of duties — spreading responsibility for financial processes across multiple employees — is a key tenet of effective internal controls. When multiple employees verify financial data, it’s less likely that any of them will mismanage finances — either accidentally or for their own gain. This produces accurate financial statements that boards can reference, and investors can trust.
11. Prevent harmful scandals
Organizations suffer far-reaching reputational damages when scandals come to light, especially those that harm investor finances. For example, Enron was found guilty of hiding debts in 2001, and that reputation followed them for decades — largely because they lost shareholders millions of dollars in the process. Accounting internal controls create a hostile environment for misreporting and other types of fraud, leading to more trustworthy practices.
12. Streamline external audit
Like internal controls themselves, external audits are a regulatory requirement. Though you can’t avoid an audit, internal controls can increase the chances of winning a clear report. What’s more, if you can prove the extent of your internal controls system, you may reduce the audit scope — leading to reduced audit time and fees.
13. Achieve corporate goals
Good internal controls are mapped to corporate goals and objectives. Risk teams will identify the practices the organization needs to achieve those goals and then design internal controls that allow those practices to be safely completed.
Turn internal controls into your competitive advantage
Internal controls may seem like a system that runs in the background. But if they’re at the forefront, internal controls are an essential tool to achieve your objectives — and edge out your competitors in the process.
Internal Controls Management from Diligent automates manual functions, expands your oversights and frees up risk teams to pursue more strategic tasks. Learn more or request a demo to see how.
