How to Design an Internal Control System

by Angie Mohr; Updated September 26, 2017

Designing an internal-control system for your business takes planning and an understanding of the detailed operations of the company. Internal controls serve several purposes, but the main ones are to ensure that the business operates as intended and to prevent opportunities for employees to misappropriate goods or money. Internal controls allow a business owner the peace of knowing everything is working properly without having to personally oversee every facet of the operation.

Step 1

Review each of the major processes in your business: production, inventory management, accounts receivable, accounts payable, bank reconciliation and any other process where it might be possible to perpetrate a fraud by theft or concealment. Put names or job titles on each part of the process that an individual is responsible for. If you are not sure how a process works, spend time "in the field" and watch the process or ask questions of those responsible.

Step 2

Assess each step of each process for weaknesses in control that would allow an opportunity to steal company assets. Focus on areas where a single individual has both custody of assets and the accounting for them. For example, if one employee has control over the cash register and also is responsible for reconciling it at the end of the night, the employee has the opportunity to steal money and hide it by falsifying the reconciliation. Another example is having a single employee responsible for opening the incoming mail and also being responsible for recording the accounts-receivable checks that arrive in the mail.

Step 3

Change the procedures for those areas where you have assessed weak internal controls. Separate the custody function from the reporting function wherever possible. While you may not have enough employees to have different people do each job, alternate functions amongst the employees you do have to segregate incompatible functions wherever possible.

Step 4

Document the new procedures thoroughly and familiarize employees with them. Solicit feedback from the employees as to how efficient the new procedures are. It is important to make sure that the procedures make sense from a business and operational point of view and not just as a control. Adjust the procedures according to feedback but always keep in mind the purpose of the controls.

Step 5

Implement a mandatory vacation policy, if you have not done so already. The majority of chronic-theft problems in businesses are allowed to continue because no one else ever performs the functions of the thief. When thieving employees are forced to take a vacation and someone else fills in for them, they cannot keep concealing the crime. This policy can prevent theft as well as uncover it if it does happen.

Tips

  • Assess the effectiveness of your internal controls at least annually and improve them if necessary.

Warnings

  • Do not be afraid to implement strong internal controls because you fear your employees will think you don't trust them. Honest employees want to work in a properly-designed environment.

About the Author

Angie Mohr is a syndicated finance columnist who has been writing professionally since 1987. She is the author of the bestselling "Numbers 101 for Small Business" books and "Piggy Banks to Paychecks: Helping Kids Understand the Value of a Dollar." She is a chartered accountant, certified management accountant and certified public accountant with a Bachelor of Arts in economics from Wilfrid Laurier University.