Too many businesses never think about internal controls until they start losing efficiency, investors demand it, or a financial disaster occurs. Even though many growing businesses are run informally, it's important to establish a company culture of success early on. This includes creating internal controls that can scale with your business.
Getting Started with Keeping Books
The typical early-stage business is a small handful of partners operating out of a garage or shared office space. They work closely together and are in constant communication about every aspect of the business. Much time may be spent trying to generate sales or manage cash flows to survive another month. Any other business activities may be seen as a luxury.
Because the partners often know each other well and everyone has an equity stake in the business, there's often an assumed trust and belief that everyone will place the business's interests first. The majority of the time, that assumption is a good one, and everything will go smoothly.
Unfortunately, there is still a risk that something can go wrong, and if it does, the entire business may be at risk. It's also always wise to start good habits early. Early-stage businesses should put the following controls in place:
- Start keeping complete, accurate and timely records now, even if it's just logging everything into an Excel sheet. Don't wait until the end of the quarter or year to hire an accountant to figure out if you have as much money as you think you do.
- Every financial transaction and decision should require the consent of at least two partners. This isn't just about theft — it also helps to ensure there is agreement before any spending.
- Reconcile receipts, bank statements and internal records in a timely fashion. When getting your cash flow predictions right is necessary to your survival, accuracy is critical.
Hiring Your First Employees
Once the founders become overwhelmed with the work it takes to keep their business running, hiring employees is the next natural step. Often, this will be some sort of expert in an area the founders lack expertise in such as accounting, marketing, purchasing or supply chain management.
No matter how skilled or trusted an employee is, he or she should never have sole responsibility over any are of the business. A partner should regularly review the work — don't just sign off on whatever reports are presented. An alternative is having two employees handling related tasks so that their work can be cross-checked.
For example, the accounts receivable employee's work can be checked to see if it matches against the sales employee's work. If you're having trouble keeping two sets of eyeballs on everything, outsourced bookkeeping services or other third-party services can give you that extra check you need to guarantee accuracy.
If you haven't already, this is also the time to create your employee handbook and formal job descriptions. This ensures that every employee knows which tasks to perform, and it allows for better continuity whenever someone decides it's time to move on.
Creating An Accounting Department
When hiring reaches double digits, it's usually time to group employees into different departments. This stage is almost a repeat of the initial hiring stage, but tasks are delegated to departments instead of individual employees.
The key here is to divide tasks within a department to maintain the principle of at least two employees looking at everything. Additionally, tasks should still be divided in a way that keeps a single employee from having access to manipulate the books to conceal a fraud. For example, the employee entering payments received shouldn't be able to alter the sales log. Instead, one employee should handle all sales entries, and another should handle all payment entries.
A typical control structure is as follows:
- An employee completes a task.
- The work is cross-checked against a connected task completed by another employee (e.g., sales and receivables).
- The department manager reconciles the work of both employees, ensures it matches, and spot-checks individual transactions.
- A founder or executive reviews the department manager's reports and may personally audit a portion of the transactions or ask the company's controller services to conduct an audit.
If you're still too small to properly divide all tasks or lack the internal resources to manage your accounting, you can look to outsourced bookkeeping services or implement more thorough reviews by each employee's supervisor.
Scaling as a Mid- to Large-Sized Business
As you grow larger, the general principles remain the same. The main difference is that there is a need for more formality and adherence to Generally Accepted Accounting Principles if you decide to go public or if private investors demand better books. You should look to answer the following questions:
- Have you previously made a decision that trades full separation of duties or other best practices for reduced staffing or outsourcing expenses?
- Are any of your current practices affecting the accuracy or completeness of your reports?
- Is your financial data updated in a timely manner?
- Do your existing controls leave opportunities for employee fraud?
If you don't have satisfactory answers to every question, follow the same principles you did early on. Bring in senior managers with expertise you're lacking, create documented policies and procedures that eliminate shortcomings, and bring on internal or outsourced staffing to ensure that every task is covered. After each step, reevaluate, and continue the cycle until you are convinced your internal controls are as strong as they can be.
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