If we had to define the term internal controls for small businesses, we’d probably phrase it like this: "Checks and balances that owners put in place to ensure that their accounting is accurate and their employees don't rip them off."
That second part might sound a bit harsh but the reality is over two-thirds of frauds are committed by employees who are placed in positions of trust, and most small businesses have relaxed work environments with little or no supervision.
With that in mind, here are a few ways you can improve your company’s internal controls:
1. Establish good general controls
Lock your registers and file cabinets. Manage your passwords carefully. Keep your blank checks in a secure place. These are all basic, common-sense security measures but they're easily overlooked when you’re busy with the 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 and/or keeping cash payments from customers and then adjusting the sales receipt), stealing inventory, falsifying expense reports, and writing checks to fake 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 someone other than the person who writes the checks. If you have a cash register, daily cash receipts should be crosschecked 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 you should review and approve each payroll run before it gets submitted for processing.
4. Keep an eye on your bank account
If there’s anything strange going on with your business (such as phony checks or unauthorized withdrawals), it’ll usually show up during the bank reconciliation (or "bank rec"). Although you may think the bank reconciliation is just a tedious monthly chore, it's actually a key accounting procedure and a vital check-and-balance for every small business. In fact, one of the best internal controls you can get is to have your bank rec done by an outside accountant every month. Also, you (the owner) should take time to scan 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 any small business can have is the overall atmosphere created by the owner (accountants call this the "control environment"). You should stay hands-on with the financial side of your business, not just hand everything over to a bookkeeper and trust that it's being done correctly. Take an interest in the accounting, review large invoices before they get paid, look at your financials 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 numbers... and that's always a good thing.