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Blog > The Role of Internal Controls and Risk Assessment in Organizations

The Role of Internal Controls and Risk Assessment in Organizations

VComply Editorial Team
February 6, 2023
4 minutes

In today’s fast-paced and digitalized world, organizations are exposed to numerous risks that can jeopardize financial reporting or result in the loss of business assets. To prevent unintentional but expensive errors and premeditated fraud, and to improve financial reporting, organizations must set up a strong internal control system. 

The role of internal controls is to help companies to comply with laws and regulations and prevent risks and fraud.
If you implement correctly, effective internal controls enable organizations to provide value to their stakeholders and achieve their strategic goals, all while staying compliant with laws, regulations, and industry best practices to minimize risks.

In this article, we dive deeper into the role of internal controls and risk assessment for organizations, how to create and implement internal controls, and the importance of risk assessment in creating an effective internal control system. 

What are internal controls? 

Internal control refers to the policies, strategies, and practices that organizations establish to enhance their risk assessment architecture and provide solutions to prevent losses or fraud.

The internal control environment, according to the Institute of Internal Auditors, is the “basis on which an effective system of internal control is constructed and operated in an organization that aims to –

  1. Fulfill its strategic goals.
  2. Provide both internal and external stakeholders with trustworthy financial reporting.
  3. Conduct business effectively and efficiently.
  4. Adhere to all applicable rules and laws.
  5. Protect its resources.

Therefore, a system of internal controls can be seen as a crucial component of daily operations that can reduce risks and increase revenue. In simple terms, a good risk assessment program with a system of strategic internal controls can empower executives and investors to manage the organization efficiently. 

What is the importance of internal controls in compliance and operations management?

Compliance and internal control are frequently used interchangeably. 

  • Internal control is the process created to achieve a specific objective. 
  • Whereas compliance is the application of the proposed process. 

For instance, your goal is to keep the data on your computers safe. You should implement security measures and internal controls such as mandating passwords, establishing password complexity guidelines, and updating passwords every 60 days. Therefore, you need to change the password and the security standards using a set of internal controls.

Failure to incorporate internal controls in place results in a poor organizational reputation. In a recent example, the U.S. Securities and Exchange Commission (SEC) charged the telecommunications and technology systems company with conducting a multi-year accounting scam due to a lack of internal controls. Similarly, there are several instances each year where organizations lose millions of dollars on their own due to non-compliance, fraud, and misbehavior.

The fact that each of these outcomes results from a weak internal control system emphasizes how crucial internal control is to an organization’s success. Strong internal controls assure management and other stakeholders of a fair level of comfort that the organization is operating by its own standards, those of the industry, and legal and regulatory obligations.

How do you successfully implement internal controls?

When establishing an internal control environment, the sequence of steps taken matters, just like in any process. An organization cannot skip phases in planning, implementing, running, and monitoring its internal control structure.

Here’s a 5-step strategy to successfully incorporate internal controls in your organization.

Step 1: Establish a reliable internal control environment

Any organization’s foundation is built on its structure, ethics, and integrity. These factors also lay the groundwork for an appropriate control environment and access restrictions inside an organization.

Step 2: Incorporating internal controls & risk assessment strategies

Initially, organizations must recognize, examine, and evaluate the risks within their company. This review technique will assist their compliance management and risk assessment teams to determine what policies, practices, and internal control systems are in place—or aren’t—to reduce the risks to company operations, financial reporting, and compliance requirements. 

Step 3: Set control activities into effect

Organizations should design appropriate internal controls (such as policies regarding signing big controls or employee training on working with third parties) and apply those controls as soon as the risk assessment reveals any controls that might not be adequate for the risks facing the company.

Step 4: Share what you’ve learned

This establishes a structure where employees can voice any worries or issues, such as fraud or other types of misconduct, without worrying about facing the consequences. An equally important aspect is to provide employees with the knowledge and tools they need to perform their responsibilities properly.

Step 5: Continuous monitoring 

Both risks and business processes change with time. Further, internal controls can fail to perform as well in practice as anticipated. This means that risk assessment and compliance teams should keep an eye on how internal controls are working, conduct regular audits, and review risk assessments frequently to ensure your internal control system remains successful.

An internal control review process ensures that controls work as envisioned and do not adversely affect operational effectiveness. To ensure that issues are rectified, findings and discrepancies should be assessed before corrective measures or controls are put in place.

The importance of risk assessment in establishing an effective internal control system

Depending on the size, sector, age, and nature of the business, each organization will have a distinct internal control system. Nevertheless, the operation and core elements of all efficient internal control systems are essentially the same.

One such critical core element is risk assessment. It examines the risks that could jeopardize the company’s capacity to accomplish its goals and then evaluates whether the internal controls’ structure and operation provide the appropriate level of security.

Risk assessments are crucial because they help you locate areas of vulnerability in your internal control system. For instance, you can find that existing internal controls are no longer effective because your company’s operations have changed, or you might detect new external risks that can get through them.

Key factors to take into account when performing risk assessments:

  • The sector in which your firm operates
  • The general state of the economy
  • The scope of your organization
  • Changes in the regulations
  • The strategic plans and goals of your organization
  • A possible exit strategy—such as if your business intends to go public (either traditionally through an IPO or through a special-purpose acquisition company)

By first sorting and prioritizing the above factors, emphasize what matters most and where there is potential to apply internal controls. After you’ve listed possible risks, it’s essential to understand the kind and scope of your company’s involvement. This entails examining associated processes to find any flaws or gaps that could pose a risk.

After the specific processes have been examined and improved, the next stage is to look at any potential internal controls already in place and improve them or create new ones if necessary.

5 Best practices for internal controls

Internal control environment

The first step for every organization must be to create its internal control environment. Five factors to successfully implement change include – a clear vision, skills, incentives, resources, and a plan.  

Internal control risk assessment

The next best practice is to assess and identify any risks or threats to the organization’s goals. Read VComply’s blog to understand the internal control risk assessment component in greater detail. This ongoing process needs to be carried out at least once a year to stay compliant.

Internal control activities

Control activities are designed to address and mitigate risks to meet organizational goals. Internal control considers this a crucial component.

Control activities are divided into many types and categories based on their nature and number within an organization. They ought to be clear activities that may be seen and recorded for later review or re-performance by a third party. 

Importance of communication internally

Employees in the organization must be aware of their roles in internal control. This is best accomplished when people can relate how their actions affect the accomplishment of the company’s goals and objectives. This communication needs to be consistent. 

Further, organizations with truly effective internal control regularly train their employees, make sure that they have access to the most recent policies and procedures, and promptly convey any other important information via company meetings or emails as necessary.

Monitoring internal control activities

Similar to how control activities support ensuring that risk management activities are carried out, monitoring helps ensure that control activities and other planned actions to implement internal control are carried out correctly and on schedule to produce effective internal control.

To stay current and effective, internal control processes must be reviewed and updated regularly.

Enhance your internal control infrastructure and simplify risk assessment with VComply

In a world where organizations are exposed to many risks, internal control, and risk assessment software come in handy. With a framework for internal controls, VComply for control management streamlines the risk assessment process. 

With VComply, you can:

  • Access the library of pre-established rules, compliance frameworks, and control mechanisms.
  • Use the control workspace provided by VComply to collaborate with teams and stakeholders.
  • Automate risk analysis, then look for gaps.
  •  Automate control delegation, reporting, review, and effectiveness of organizational control evaluation.
  • Implement strategies for risk mitigation and link controls to risks.

VComply can streamline your efforts and simplify internal control activities and risk assessment, regardless of whether your organization has trouble managing cyber risk and meeting cybersecurity goals, enhancing performance management, achieving commercial objectives, or complying with legal standards.

See why VComply stands out as a G2 high performer in Compliance and Risk Management. Request your demo to see how it can drive your compliance initiatives.