Internal controls are policies and procedures designed to help your business safeguard its assets, maintain financial accuracy and achieve operational objectives. The latter often includes meeting stakeholder expectations and achieving regulatory compliance.
Naturally, as your business changes, you must update its controls to maintain their effectiveness. However, doing so without leaving gaps or creating excess process drag can be challenging.
This guide provides a framework to help you right-size your company internal control system at each growth stage.
Why Your Company Internal Control System Needs to Evolve
In its earliest stages, the internal control system of a company often revolves around a handful of founders. Oversight is typically informal, depending heavily on their direct involvement in every aspect of operations.
This approach is highly beneficial when teams are small and bandwidth is limited. Founders can prioritize speed and efficiency over formal controls, frequently making trust-based systems the most practical option.
However, this becomes increasingly problematic as your business expands. By the time you’re operating at scale, organizing controls around a few key individuals invites fraud, data silos, financial reporting errors and other intolerable risks.
For example, say a founder manually approves every invoice for the first year of operations. When transaction volume triples, this becomes a bottleneck that can result in missed payments and rushed approvals, opening the door for cash flow issues and fraudulent payment requests.
The Risks of Misaligned Controls
When designing internal controls, your fundamental goal should be to align them with your company’s current risk profile. Both “under-controlling” and “over-controlling” can be detrimental to your operation.
Under-controlling occurs when you have insufficient oversight, documentation or ownership of procedures. This is typically the primary concern with internal controls, leaving your company vulnerable to traditional control weaknesses.
However, the risk of over-controlling is often underrated. This occurs when you introduce unnecessary or excessive controls, resulting in process drag. This wastes resources, slows down operations and stifles employees.
Right-sizing internal controls to your current business growth involves striking a healthy balance between these two extremes, implementing necessary protections without creating bottlenecks of complexity.
How to Right-Size Business Internal Controls
Business risks naturally evolve alongside your company. As a result, tailoring internal controls to your current stage of development is the key to creating an appropriately rigorous system.
This stage-based framework will help you determine what your internal control system should look like at each phase of growth.
Stage 1: Founder-Led Operations and Visibility-Based Systems
In the initial stages of a startup or small business, internal control systems are often informal by necessity. With teams consisting of only a few founders, segregation of duties and other rigid procedures tend to be unrealistic and counterproductive.
Instead, early control systems should prioritize:
- Shared financial visibility: All members of the founding team can readily view activities across company bank accounts and credit cards.
- Practical approval procedures: Expenses above an agreed-upon threshold require review by more than one founder.
- Clean financial separation: Founders ensure they conduct personal and business transactions through separate accounts.
- Centralized documentation: Contracts, financial records and other important documents are maintained in a secure location.
These practices help minimize risky blind spots without introducing unnecessary friction. They also lay a strong foundation for the future, making it easier to implement additional controls as you scale.
Stage 2: Growing Transaction Volume and Initial Hires
As transaction volume increases and financial responsibilities begin shifting to new hires, founder-dependent controls become harder to sustain. At this stage, your company should introduce a more formalized, structured system.
Some important controls to focus on include:
- Basic segregation of duties: No single individual controls the full lifecycle of a transaction, such as initiating, approving and recording vendor payments.
- Role-based access controls (RBAC): New employees only have access to the tools and data they need to fulfill their role in your organization.
- Defined financial ownership: A founder or early hire is clearly accountable for maintaining the books and overseeing financial processes.
- Consistent reconciliations: Someone performs bank account and credit card reconciliations on a timely basis each month.
This stage marks the transition beyond founder-centric, visibility-based controls. You still may not need an overly formal or complex system, but you should introduce reliable checks and repeatable procedures that can scale efficiently as you continue to grow.
Stage 3: Scaling Operations and Formalized Processes
When headcount and transaction volume start increasing rapidly, partially defined internal controls start to break down. At this stage, your organization should formalize controls and standardize processes across the business.
Some key goals to achieve include:
- Fully documented workflows: Documentation maps out procedures from start to finish, eliminating reliance on tacit knowledge and ad hoc steps.
- Consistent process execution: Teams follow established procedures as written, reducing variability in operations across periods.
- Clearly defined responsibilities: All processes belong to specific employees, removing ambiguity and preventing tasks from slipping through the cracks.
- Mature month-end close process: The finance team closes the books on the same timeline each period, delivering complete, accurate and timely data.
During this phase, your company internal control system should get away from reliance on individual judgment. Instead, it should revolve around well-defined workflows that employees execute consistently across the organization.
Stage 4: System Complexity and Control Automation
As companies continue to scale, operations tend to become increasingly dependent on multiple software systems. Eventually, manual controls and workarounds will struggle to keep pace with activity and complexity levels, resulting in bottlenecks.
To maintain control effectiveness, concentrate on:
- System-enforced controls: Software enforces policies and procedures directly, reducing reliance on manual oversight and ensuring consistent execution.
- Updated authorization model: Access controls evolve past simple role-based permissions to more dynamic structures that reflect how users interact with data.
- System integration oversight: Data flows accurately between systems, reducing manual entry and ensuring consistency across financial platforms.
- Automated accuracy checks: Systems automatically flag discrepancies, match transactions, and validate data across workflows.
In this stage, your business internal controls should become almost entirely systems-driven. You’ll need the increased efficiency of automation to maintain consistent oversight across your rapidly expanding operation.
Stage 5: External Scrutiny and Compliance Readiness
As your company approaches maturity, its internal controls will often have to satisfy external scrutiny. Whether from lenders, investors or regulators, you’ll likely face control requirements that differ from those you set internally.
At this point, your focus should typically be on:
- Alignment with external frameworks: Internal controls align with applicable standards, such as SOX compliance requirements or GAAP for a financial audit.
- Periodic testing and validation of controls: Managers periodically evaluate whether controls operate effectively and address any gaps.
- Maintenance of reliable audit trails: Key controls leave an audit trail that details the who, what, when and why of each instance.
This is the stage in which your company internal control system should become fully realized, capable of supporting not just in-house goals, but the shifting expectations of various external stakeholders.
The Role of Finance Leadership
Internal controls are a complex component of financial management. Designing and maintaining an effective system often requires specialized expertise, especially once external frameworks come into play.
This makes experienced finance leadership crucial, such as from a controller or a CFO. These professionals can assess where gaps exist, determine which controls to implement, and ensure your system operates consistently in practice.
However, hiring a full-time finance executive isn’t always feasible. For many growing companies, the additional overhead can be difficult to justify, particularly if your needs are evolving rapidly or you don’t require full-time support.
This dilemma has made fractional financial services an increasingly attractive option, which help you access expert guidance while maintaining flexibility.
Find Fractional Control Support Through Paro
A company internal control system isn’t something you can set and forget. As your business grows, its processes, systems and risks will continuously evolve, requiring its controls to evolve with them.
Conducting regular assessments and updating your system proactively is the best way to ensure controls keep up with growth, especially when your efforts are led by an experienced financial professional.
Paro’s fractional controller or CFO services can help you close any bandwidth or expertise gaps your team may face. Schedule a free consultation to get support tailored to your unique needs.
