If we had to define the term internal controls for small businesses, we’d probably phrase it like this:
“Internal controls are checks and balances that business owners put in place to ensure that their accounting is accurate and their employees don't rip them off.”
That definition might sound a bit harsh, but the reality is that over two-thirds of accounting and financial frauds are committed by key employees in positions of trust. And unfortunately, most small businesses have loose environments with very few controls or safeguards in place.
With that in mind, here are a few ways you can improve your company’s internal controls:
1. Establish good general controls
Manage your passwords carefully. Lock your registers and file cabinets. Keep your blank checks in a secure place. These are all basic, common-sense measures — but they're easy to overlook when you’re busy with the day-to-day details of running a business.
2. Be aware of the classic fraud tricks
Cash and inventory are by far the biggest sources of fraud for small businesses — especially retailers. The most common tricks used by employees include skimming (taking cash from the register or keeping cash payments from customers and then adjusting the sales receipt), stealing inventory, inflating expense reports, and writing checks to fictitious vendors (such as friends or relatives).
3. Don’t let one person do everything
Segregation of duties isn’t always possible at small businesses, so a good rule of thumb is this: When it comes to your accounting, don’t let one person do everything. Your bookkeeper should not be the check signer. Your bank reconciliation should be done by somebody other than the person who writes the checks. If you have a cash register, your daily receipts should be double-checked and deposited into the bank by somebody other than the store manager. If you have employees, you (the owner) should know your average payroll totals and approve each payroll run before it gets submitted for processing.
4. Keep a close eye on your bank account
If there’s anything strange going on with your business (like phony checks or unauthorized withdrawals), it’ll usually show up during your bank reconciliation (or "bank rec"). Although you may think the bank rec is just a tedious monthly chore, it's actually a critical accounting procedure for any small business. In fact, one of the top-recommended internal controls for small businesses is to have your bank rec done by an outside accountant every month. Also, you (the owner) should look at your bank account on a regular basis and ask questions about anything that looks unusual.
5. Stay hands-on with your accounting
Believe it or not, the single most important internal control for any small business is the overall atmosphere created by the owner (CPAs call this the "control environment"). In other words, you should stay hands-on with the accounting and financial side of your business — not just hand everything over to an employee and trust that it's being done correctly. Take an interest in the numbers. Review large invoices before they get paid. Look at your financial reports on a regular basis. And ask lots of questions. In addition to keeping you informed, these actions show employees that you’re paying close attention to the accounting... and that's always a good thing.