Internal Control Benefits for Tech Start-ups
10.20.22 | Industry Insights
A strong system of internal controls protects a company’s assets against fraud and ensures timeliness and accuracy of financial information. The process of creating a rigorous internal control environment should begin early in a company’s life cycle, no matter the size. Without an effective and efficient system, company growth cannot be sustained. This is critical for technology and life sciences start-ups as they often neglect certain accounting practices to focus solely on growing sales and their market niche. Doing this typically results in these companies having cash flow management issues and inaccurate reporting of earnings data.
One of the first steps in setting up internal control systems is to identify major accounting cycles and align them with threats and risks that will enable a company to achieve its strategic objectives, followed by the documentation of processes and policies for each cycle. These cycles typically include:
- Revenue and receipts
- Disbursements, payroll, and fixed assets
Written policies should clearly communicate specific responsibilities for each individual involved in the financial reporting process and address initiation, recording, authorization, and approval of transactions.
The documentation should state who within the organization is going to ensure the processes are followed and what the consequences will be when they are not. The policies in place need to be reviewed by management periodically to evaluate their effectiveness and relevance as the technology and life sciences company grows and volume and complexity of transaction changes.
What makes a strong internal control policy?
A system of internal checks and balances is founded on a principle of segregation of duties. The life of an accounting cycle follows the same phases on a transaction level: initiation, approval, processing, recording, reconciling, and reporting. A cycle begins with a single transaction, which in most cases can be traced from an initial posting/journal to a final closing trial balance.
In general, a single person involved in a key accounting process should not have the ability to control the lifespan of a transaction and have the custody of assets related to it. Having shared responsibility creates transparency in processes and helps minimize the risk of mistakes and their concealment. Below are examples of incompatible duties that should be segregated, when possible:
Revenue and receipts cycle
- The same individual receives payment from the customer (check or cash) and records the transaction in the general ledger
- The same individual makes deposits and reconciles bank statements
- The same individual approves and processes payroll
- The same individual approves and records purchases in the general ledger
- The same individual who receives the goods is involved in the purchasing
Segregation of duties is key and ideal in each cycle but may be difficult to achieve due to a small accounting department or impracticable due to low volume of transactions in early stages of a technology and life sciences company’s development. Constraints of a small accounting department and overall company size can be mitigated by having compensating management and entity level controls in place.
Examples of management control:
- CEO opens and reviews bank statements
- CEO reviews bank reconciliations
- CEO reviews and approves payroll
Examples of entity level controls by the board of directors:
- Review of monthly financial statements
- Review and approval of significant expenditures
- Review and approval of new contracts
It is important to have internal controls in place and operating effectively throughout the life cycle of the company. As mentioned above, adequate controls help mitigate the risks of errors and fraud. They also provide management and investors with confidence in financial statements and are a focal point of due diligence. Segregation of duties is only one of the elements of a strong internal control environment, but a critical starting point for implementing a strong system.