The Role of Internal Controls in Effective Risk Management

Internal controls—or the policies, procedures, and systems that safeguard assets and ensure compliance—are essential for managing risk. They help organizations prevent fraud, prevent and detect errors, and meet regulatory requirements. Beyond risk mitigation, internal controls enhance financial accuracy, protect critical assets, and improve efficiency. When aligned with organizational goals, they create a framework that supports informed decision-making and long-term stability.

Key Elements of Effective Internal Controls

There are several key elements that contribute to a strong internal control framework. These include:

• Segregation of Duties. Ensure no one person has control over all (or too many) aspects of any critical financial transaction. This reduces the opportunity for errors or fraud to occur.
• Access Controls. Limit access to sensitive financial information and financial system functions to only those who need it to perform their job functions to reduce the chance of misuse or unauthorized access.
• Documented Procedures. Clearly define and document policies and procedures to ensure consistency across the organization and that employees understand their roles and responsibilities. Disseminate the policies and procedures and require those with access to sign off annually that they have read and understand them.
• Monitoring and Auditing. Monitor and periodically audit processes and deliverables to identify areas where gaps in internal controls exist or where improvements are needed. Continuous feedback helps to strengthen controls in real-time.
• Automated Controls. Automate internal controls with advanced technologies, such as enterprise resource planning (ERP) systems, to enhance accuracy and efficiency. Automation reduces human error and speeds up transaction processing.

Identify and Document Control Activities

The first step to assessing the strengths and weaknesses of your current control environment is to identify and assess the risks your organization faces. Typically, these risks are documented in a risk register. Once these risks are clearly identified, the next step is to establish appropriate controls to mitigate them.

This includes determining which specific controls are in place to address each identified risk and how these controls are executed within your processes. Understanding the concept of something like segregation of duties is only beneficial if the segregation is clearly defined and enforced. Conducting an analysis of your processes and identifying what controls are in place is crucial in not only making assessments but also in measuring the effects of any changes and improvements.

Create a matrix of your processes and workflows and use that as a guide to determine which activities are currently implemented and where your process may still be undeveloped. Solicit help from department managers, team leaders, and staff to fully understand the whole picture. Written policies mean nothing without adherence. Examine your written policies to verify that they’re still applicable to current organizational practices and hierarchy. Ensure that responsible parties and timelines are clearly defined. This framework will serve as the foundation of your organization’s control environment.

Identify Weaknesses in Existing Controls

The next step to strengthening internal controls is to identify areas of weakness. This may be a challenge for many organizations, especially if their processes have evolved without regular assessment. Gaps often emerge when businesses grow too quickly or undergo significant changes, leaving controls outdated or insufficient. In addition, information systems functionality evolves with new releases and controls, which may be able to be strengthened by adopting new functionality. A governance, risk, and compliance (GRC) or a compliance officer may be able to identify weaknesses by systematically examining the outlined process and considering scenarios where controls have failed; other weaknesses may be identified by input of pain point or concerns from team members or even vendors/customers.

Inconsistent financial reporting, delays or errors in transaction processing, high employee turnover, and under-defined processes are all signs of potential weaknesses. By conducting regular audits and internal reviews, you can uncover vulnerabilities and implement stronger controls to mitigate risk, maintain data integrity, and create accountability.

Compliance and Regulatory Requirements

Beyond preventing fraud and enhancing operational efficiency, internal controls are essential for ensuring compliance with both industry-specific and general regulatory standards. In a landscape of evolving regulations, reporting requirements, and advancing technology, organizations should remain vigilant to avoid missteps that could affect many aspects of business continuance. Errors can affect things like satisfying funder requirements, revenue cycle management, acquiring clients, and much more. A well-developed and maintained internal control system ensures that companies can meet these demands and avoid costly penalties or legal complications.

For those organizations in sectors that heavily rely on funding agreements from foundations or public institutions, such as healthcare or affordable housing, internal controls are particularly important to satisfying the obligations of their grants or contracts. These industries face strict compliance requirements related to data privacy, beneficiary eligibility, and operational transparency. Without effective controls in place, maintaining compliance and reporting on activities becomes more difficult, and the risk of losing existing and potential funding increases. A robust internal control framework helps mitigate this risk by providing the necessary checks and balances to meet funding obligations.

Businesses operating in highly regulated sectors, such as healthcare and fintech, are held to higher standards of regulatory compliance and data security. Control failures in these heavily regulated markets can have drastic consequences, both to the financial health of the business and to the clients it serves. Strong controls mitigate the risk of these errors.

Create a Culture of Accountability

Most of us have heard of “tone at the top”, but leadership is not able to be everywhere at once. Responsible leaders play a key role in establishing a culture where internal controls are valued. When management prioritizes accountability and transparency, it sets a clear example for the rest of the organization. Clearly defining expectations and ethical standards reinforce the importance of internal controls at every level.

Regular training and open communications ensure employees understand their role in supporting these controls. By empowering staff to take responsibility for maintaining these practices, you create a culture of shared commitment across the board.

Ongoing Evaluation and Improvement

Internal controls must be continuously evaluated and refined. As businesses grow and face new challenges, their control systems must adapt accordingly. Regularly scheduled assessments and updates ensure controls remain relevant in addressing new risks, regulatory changes, and technological developments.

A proactive approach to evaluating internal controls helps businesses identify and address potential risks before they escalate. The frequency at which controls are re-visited should be documented and adhered to, be it at quarterly status or annual executive meetings. This approach not only creates accountability and awareness but also protects the risk management strategy from being neglected from management turnover. This strategy will promote continuous improvement, allowing organizations to fine-tune their processes in alignment with shifting strategic goals.

Incorporating robust internal controls into your risk management framework is critical to ensuring financial stability, operational efficiency, and regulatory compliance. Through ongoing evaluation and refinement, you can strengthen control systems, mitigate risks, and create a firm foundation for sustainable growth.

How We Help

AAFCPAs’ Business Process & Internal Controls consulting practice helps clients optimize operations by ensuring efficiency, effectiveness, and strong internal controls throughout the organization. As the organization grows or changes and information systems evolve, processes often fail to evolve at the same pace. We focus on aligning business processes with information systems, ensuring smooth and effective operations.

Our team brings expertise in business operations, IT consulting, and process improvement. By using cross-functional teams and a collaborative approach, we identify opportunities to improve workflows, integrate technology, and implement solutions designed to eliminate repetitive tasks and reduce human error.

These insights were contributed by Robyn Leet and Stuart Karas. Questions? Reach out to our authors directly or your AAFCPAs partner. AAFCPAs blog offers a wealth of resources related to Business Process Improvement and Risk Management. Subscribe to get alerts & insights in your inbox.