Internal control and monthly management reporting for small and medium-sized businesses

Internal control is often seen as something for large or listed companies, but in reality small businesses are the most exposed, because so much of the work rests with just a few people. When an error or a fraud occurs, it is often months before anyone notices.

The good news is that effective controls do not need a mass of procedures. This article brings together basic controls that small and medium-sized businesses can realistically put in place, and the set of monthly reports management should see.

What is internal control?

Internal control is the policies and procedures that give assurance that the business operates towards its goals, its financial figures are reliable, its assets are safeguarded and it complies with the law. The core idea is to design things so that errors are found early and fraud is hard to commit.

Segregate duties clearly

The most important principle is that no single person should handle a whole process from start to finish. The three roles that should be kept apart are:

• The approver: approves purchases, payments or discounts
• The recorder: records transactions in the accounting system
• The custodian of assets: holds the cash, manages the bank accounts or looks after the stock

If the team is too small to separate all of these, use compensating controls, for example a senior manager reviewing the bank statements personally every month, or requiring two people to approve every transfer made through the bank's system.

Put approval authority in writing

An approval authority table lets everyone know who must approve which type of expense, and up to what amount. For example:

The figures in the table are only an example. Each business should set its own according to its size and risks, and review them at least once a year.

Reconciliations to carry out every month

1. Reconcile every bank account and follow up items that have not yet cleared the bank.
2. Compare the receivables and payables balances in the general ledger with the detailed listing for each customer and supplier.
3. Count petty cash from time to time without advance notice.
4. Count part of the stock on a rolling basis throughout the year, rather than waiting for a single count at year end.
5. Compare the tax reports with the returns actually filed.

The monthly management report pack

A good report is short, can be read in a few minutes and leads to a decision. The recommended basic set is:

• Profit and loss against budget and the previous month: with explanations for any large variances
• Cash flow and a 13-week forecast: to see in advance when cash will be tight
• Receivables ageing: balances overdue by more than 30, 60 and 90 days, with the person responsible for chasing each one
• Payables ageing: what has to be paid in the coming month
• Key business indicators: such as gross margin, sales per customer or inventory turnover

Warning signs not to ignore

• A large number of adjusting entries with no explanation
• New suppliers who receive payment without going through the approval procedure
• Customers who receive discounts or credit notes unusually often
• Staff who never take their annual leave and never let anyone else cover their work

Frequently asked questions

Where should a company with only one accounts employee start?

Start by having a senior manager approve payments and review the bank statements personally every month, separate the rights in the online banking system between the person who creates a transaction and the person who approves it, and have an outside reviewer carry out spot checks from time to time.

How often should internal control be reviewed?

At least once a year, and whenever there is a significant change, such as a new accounting system, a new branch or a change of staff in a key position.

By what day of the month should management receive its reports?

The sooner, the more useful. Businesses that close their accounts systematically every month can usually issue their reports within the first or second week of the following month.

Let us help you put internal control in place

Kerwin & Vance helps assess risks, design approval procedures and produce management reports drawn from the accounting data in good time. Find out more about our Accounting & Reporting services, or book a consultation with us.