Describe the Importance of Internal Control in Business

by Osmond Vitez ; Updated September 26, 2017

Internal controls are the standards and rules used by companies to ensure that they achieve their stated goals in the marketplace. Profitability is not only achieved through high sales and meeting consumer demand, but also from controlling costs and limiting excessive spending. Management should on a regular basis review all aspects of their company and insert internal controls that will strengthen the company and increase profitability.

Operating Environment

Internal controls help promote strong daily operations that produce high-quality goods and services at the lowest cost possible. Limiting excessive inventory, high equipment costs, and excessive utilities ensure that operational costs are maintained within a reasonable budget. Managers ensure that as goods and services are produced, machines or other equipment are properly used so any malfunctions can be avoided. Improperly using company assets can create downtime if goods have to be re-produced because of product defects.

Risk Assessment

Risk assessment is an important internal control. Every business decision comes with a certain amount of risk; avoiding or mitigating this risk is achieved through strong internal controls. Controls that mitigate risk could include capping the levels of debt used to finance operations or acquisitions, ensuring reinvestment of cash into the business, or guidelines to avoid risky securities when generating cash from investment activities. These types of internal controls prevent executive management from making potentially dangerous decisions that would have long-term effects on a company.

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Company Policies

Companies use policies to ensure a safe and profitable business environment. These policies are internal controls that help management in areas including human resources, community awareness, and business-to-business relations. Companies inform employees of these internal controls to ensure that the company’s reputation is not tarnished as a result of improperly educated employees. Publicly held companies have strong internal control policies to assure that investors are not improperly influenced by informal communications outside normal company standards.

Financial Information

The most important internal controls usually preside over the financial information of a company. Improperly reporting financial information is considered fraud and will quickly cause problems. Companies usually develop internal controls for financial information and then test them periodically to ensure that they are adequate safeguards. Publicly held companies are required to have outside auditors test their internal controls as part of the federal Sarbanes-Oxley regulations passed in 2002.

Performance Measurements

Many companies link internal controls to performance evaluations for mid-level managers and other employees. This style of performance evaluation allows companies an opportunity to educate and review internal controls with employees on a regular basis. This teaches employees the value of achieving goals through following company policy, ensuring higher profitability for the company.

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