Are Your Financial Controls Fit for Purpose?

Financial controls are a critical aspect of any business’s financial management and governance framework. They ensure that a company’s financial reporting is accurate, reliable, and compliant with regulatory standards. However, in today’s complex and fast-changing business environment, it’s essential to continually ask: are your financial controls fit for purpose?

Our blog explores the importance of effective financial controls, what makes them “fit for purpose,” common signs that your controls need improvement, and best practices to ensure they stay effective and aligned with your business needs.

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WHAT ARE FINANCIAL CONTROLS?

Financial controls refer to the policies, procedures, and processes put in place to safeguard a company’s assets, ensure the accuracy and integrity of its financial reporting.

Financial controls can take many forms, including:

• Preventive Controls: Measures designed to stop errors or irregularities before they occur (e.g., segregation of duties, approval processes).
• Detective Controls: Processes that identify issues after they occur (e.g., reconciliations, audits).
• Corrective Controls: Procedures to correct any errors or irregularities detected (e.g., error logs, follow-up actions).

To be fit for purpose, these controls must be aligned with the company’s size, industry, regulatory requirements, and risk profile.

WHY ARE EFFECTIVE FINANCIAL CONTROLS SO IMPORTANT?

Effective financial controls are essential for a number of reasons:

1. Accuracy and Reliability of Financial Reporting: Strong financial controls ensure that financial statements are accurate and complete, giving stakeholders confidence in the business’s financial position.
2. Fraud Prevention: Properly designed controls can help prevent and detect fraudulent activities, safeguarding company assets.
3. Compliance: Businesses must comply with various laws and regulations, including tax laws, industry-specific rules, and accounting standards. Financial controls are a key part of demonstrating and maintaining compliance.
4. Risk Management: Financial controls help businesses mitigate risks related to financial misstatements, operational inefficiencies, and regulatory violations.

In short, financial controls are the foundation of a well-governed business. However, to ensure that they remain effective and relevant, businesses need to regularly assess and refine their controls.

WHAT MAKES FINANCIAL CONTROLS ‘FIT FOR pURPOSE’?

Financial controls are “fit for purpose” when they effectively mitigate risks while being aligned with the company’s specific operational, regulatory, and financial requirements. To evaluate whether your financial controls meet this standard, consider the following criteria:

1. Risk-Based Approach

Controls should be designed based on the company’s specific risks. This means identifying the areas where the business is most vulnerable, such as fraud, financial misreporting, or regulatory breaches, and tailoring controls to address these risks.

For instance, a business operating in a high-risk industry like finance or healthcare, where regulations are strict and penalties for non-compliance are severe, will need more stringent financial controls than a small retail operation. A fit-for-purpose control system is risk-based, focusing resources where they are needed most.

2. Adaptability to Change

The business landscape is constantly evolving, driven by changes in technology, regulations, and market conditions. Financial controls that were fit for purpose five years ago may no longer be effective today. A flexible control framework that can adapt to new risks and changes is essential for maintaining relevance and effectiveness.

For example, companies that have adopted digital finance systems or moved to remote work environments may need to update their controls to address new cybersecurity risks and ensure secure access to financial systems.

3. Automation and Efficiency

As businesses grow, manual controls can become cumbersome and prone to error. Automating key financial controls – such as transaction monitoring, data reconciliation, and approval workflows – can improve both the accuracy and efficiency of the control environment.

Automation allows businesses to maintain robust controls without adding unnecessary administrative burdens. It also provides real-time monitoring and reporting, which can be essential for detecting issues before they escalate.

4. Clear Accountability and Segregation of Duties

One of the most important aspects of financial controls is clear accountability. Every control should have a designated owner responsible for ensuring that it is carried out effectively. Additionally, the segregation of duties – dividing responsibilities among multiple people to reduce the risk of errors or fraud – is a fundamental principle of good governance.

For example, the person who authorises payments should not be the same person who reconciles the bank account. Without proper segregation of duties, businesses expose themselves to heightened risks of internal fraud.

5. Continuous Monitoring and Testing

Financial controls should not be set and forgotten. Businesses must regularly test and monitor their controls to ensure they remain effective. Internal audits, external reviews, and compliance checks can identify weaknesses or areas for improvement.

Regular testing also allows businesses to adjust controls in response to emerging risks or changes in the operating environment. Companies that do not regularly evaluate their controls may find themselves vulnerable to risks that could have been prevented.

SIGNS THAT YOUR FINANCIAL CONTROLS NEED IMPROVEMENT

How do you know when your financial controls are no longer fit for purpose? There are several warning signs that businesses should watch for:

1. Frequent Errors in Financial Statements: If errors are consistently found during the preparation or review of financial statements, it’s a clear sign that your financial controls may be ineffective or poorly implemented.
2. Increased Incidents of Fraud or Theft: A rise in fraud, theft, or asset misappropriation suggests that your preventive controls are not working as intended.
3. Regulatory Non-Compliance: If your business is facing regulatory fines, penalties, or scrutiny from authorities, it’s likely that your compliance controls are inadequate.
4. Poorly Defined Roles and Responsibilities: If there is confusion about who is responsible for carrying out specific controls, it increases the likelihood of errors or fraud. This indicates a need to tighten accountability and clarify roles.
5. Inefficient Processes: If financial controls are overly complex, time-consuming, or reliant on manual processes, they may be slowing down business operations unnecessarily. Controls should enhance, not hinder, business performance.

BEST PRACTICES FOR ENSURING FIT-FOR-PURPOSE FINANCIAL CONTROLS

To ensure that your financial controls remain fit for purpose, consider the following best practices:

1. Conduct Regular Risk Assessments

Businesses should conduct risk assessments at least annually, or whenever there are significant changes in the company’s operations or environment. This helps to identify new risks and ensures that controls are aligned with current business needs.

2. Implement an Internal Audit Function

An internal audit team can provide an independent assessment of your controls and identify areas for improvement. Regular internal audits can also help detect issues before they become major problems.

3. Leverage Technology

Use technology to automate routine tasks and improve the accuracy and efficiency of your controls. Tools such as accounting software, enterprise resource planning (ERP) systems, and data analytics can streamline control processes and provide real-time insights.

4. Train Your Employees

Ensure that employees understand the importance of financial controls and how to properly implement them. Regular training sessions can help employees stay up to date with changes in the control environment and mitigate the risk of human error.

5. Engage with External Auditors

Engaging with external auditors provides an independent perspective on your control environment. External auditors can highlight issues you may have overlooked and offer suggestions for improving the robustness of your controls.

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Financial controls are a vital component of your business’s financial health, risk management, and regulatory compliance. However, to be effective, they need to be fit for purpose – designed to address the specific risks your business faces and adaptable to changes in the operating environment.

By conducting regular assessments, leveraging technology, and maintaining clear accountability, businesses can ensure that their financial controls remain relevant, effective, and aligned with their goals. If you’re unsure whether your current controls are fit for purpose, now may be the time to review and refine them to protect your business’s future.

Get in touch today on 01904 558 300 or email us at enquiries@fortus.co.uk, to discuss your audit needs with our team.