Q. What exactly are internal controls?

A. In an overall sense, internal controls are the procedures protecting your company’s assets and permitting it to operate in an efficient manner. From an accounting viewpoint, internal controls are the means for facilitating your accounting system. The more complicated the system, the more important it is to maintain internal controls.

Q. What happens if internal controls are not observed?

A. The result could be chaos and could even result in the eventual downfall of the company. If you do not follow a system of internal controls, your business becomes susceptible to wasted time, mistakes and, most importantly, fraud. It is important to take steps now to ensure that internal controls are in place and being maintained.

Q. How do you design a system of internal controls?

A. Start by segregating the duties of your workers. For these purposes, a job can generally be divided into four components: (1) initiation; (2) authorization; (3) custody; and (4) recordkeeping. For example, the person who writes the checks and has custody of the cash should not be the same person making the accounting entries. Similarly, the one who initiates a transaction should not be able to authorize use of the firm’s assets. Ideally, the four functions should be handled by four different people, thereby reducing the likelihood of fraud.

Q. How should you handle financial reports?

A. The best way is to set up a system of checks and balances. That means using a reliable person to check the work of others at every phase of the accounting cycle. Clearly spell out each person’s responsibilities so that he or she understands them. The top managers should supervise the process.

Q. What else can you do to safeguard assets?

A. Protect valuable items and cash through the use of lockboxes, safes, alarm systems, closed circuit monitors and other security measures. When in doubt, use common sense and remove assets from accessibility. Don’t make it easy for workers to fall victim to temptation. Key point: You cannot assume that other managers are immune. Experience has shown that long-time employees and higher-ups are more likely to embezzle funds than anyone else.

Before you hire a new employee, perform a background check and insist on several references. Then make sure you call the references. Be especially thorough if the new-hire is going to be handling the company’s funds. When it is appropriate, bond anyone who handles cash or investments.

Final word: Seek guidance from your business advisers for implementing a system of internal controls.