Internal controls are the backbone of financial integrity, especially in the eyes of regulators like the SEC. In an era where transparency is key to investor confidence, establishing effective controls is about more than checking a box—it’s about safeguarding the future of your business. Robust internal control measures ensure companies have accurate financial reporting and protection against fraud, all while staying on the right side of Sarbanes-Oxley Act (SOX) compliance.
The Connection Between Internal Controls and SOX Compliance
The Sarbanes-Oxley Act, passed in 2002, was ushered in after a wave of high-profile corporate accounting scandals. It mandates stricter internal controls over financial reporting, and is non-negotiable for companies subject to SEC regulations. If your company begins preparing for an IPO, you must install a SOX compliance framework. The controls you establish will be your first line of defense against financial mismanagement.
Components of an Effective Internal Control System
Businesses vary widely in size and scope, with remarkably different environments, management styles and risks. So while SOX section 404 establishes the need to implement internal controls for financial reporting standards, it does not demand that companies adhere to a single set of compliance procedures. However, the most effective SOX compliance frameworks have a few core things in common.
Clear executive vision: Setting the tone
Good governance comes from the top. The CEO and CFO must create a workplace culture where establishment and management of internal controls is the norm—an integral part of everyday operations—rather than a task to be ticked off as needed.
Risk assessment: Identifying and addressing vulnerabilities
An effective internal control system begins with a thorough risk assessment. This involves identifying areas where your financial reporting could be vulnerable and ensuring that controls are in place to mitigate those risks.
And though the majority of SOX provisions focus on financial accounting and reporting, some concentrate on cybersecurity regulations and the protection and storage of corporate data. Full SOX compliance involves protective measures for cyber, financial and physical security.
Control activities: Implementing safeguards
Internal control activities are the policies and procedures that help ensure management directives are carried out. Specifically, it’s excellent practice to separate or spread duties across multiple people or groups within the business to avoid human error and ensure quality assurance.
Monitoring and testing: Ensuring ongoing effectiveness
Once established, controls must be regularly monitored and tested to ensure they remain effective and accurate. This ongoing process assures that controls are functioning as intended and stay relevant as your company evolves.
How to Implement Controls and Procedures
Implementing an internal control system is a dynamic process that requires careful planning and ongoing vigilance. To effectively implement and monitor financial internal controls, take the following steps:
1. Create a step-by-step compliance framework
Start by documenting your internal controls in a formal compliance framework. This should include detailed procedures for each control, clear assignment of responsibilities and timelines for implementation.
2. Identify the right technology
Technology can streamline implementing and monitoring internal controls. Tools such as Continuous Controls Monitoring (CCM) can provide real-time alerts on potential issues to help leaders respond quickly. We go into more detail on this topic below.
3. Document control activities
Maintain comprehensive records of all control activities. Proper documentation ensures transparency and supports external audits so that it’s easier to demonstrate compliance.
4. Create compliant reports
Ensure all financial reports meet SEC standards. Workflow automation tools can help maintain documentation trails and enforce approval processes to reduce the likelihood of errors and non-compliance.
Tech and Software Support
Technology can greatly help companies establish SOX-compliant controls by automating processes and providing real-time tracking and monitoring. These tools serve different functions for different needs.
- Continuous Controls Monitoring (CCM): Automates continuous monitoring of controls and can alert management to potential issues in real time
- Enterprise Resource Planning (ERP): Integrates financial controls within broader business operations. Modern ERP systems often include modules for compliance management.
- Financial Close Management: Streamlines the financial close process, reducing errors and improving financial reporting accuracy
- Governance, Risk, and Compliance (GRC): Centralizes internal control management, risk assessment and compliance reporting
- Identity and Access Management (IAM): Manages user access rights, a critical component of IT controls for SEC compliance
Overcoming Potential Obstacles to Implementation
Implementing an internal control and compliance framework can be challenging, particularly when balancing it with other business priorities. However, by anticipating and addressing common challenges, you can streamline the process.
- Resource Constraints: With 9 in 10 executives describing their finance teams as “lean” and overextended, you will likely need to consider contract or fractional expertise to fill in any gaps in your internal capabilities. In the meantime, prioritize the most critical controls.
- Regulatory Changes: The regulatory environment is not static. Stay informed about the latest SEC requirements and proactively update and do control testing accordingly to maintain compliance.
- Technology Implementation: Adopting new tools can be time-consuming, and implementation often requires careful planning and training. Consider starting with scalable solutions that integrate smoothly with your existing systems, and ensure your team receives continuous support and training to maximize the effectiveness of these tools.
Access Internal Control Compliance Expertise
When starting or building a business, the focus is on providing products and services while minimizing OpEx and CapEx. Executive members of growing companies often perform multiple functions at once, which is excellent for bottom-line efficiency but leaves little bandwidth for establishing an effective SOX compliance framework.
But establishing and managing internal controls is essential for ensuring compliance with SOX and SEC regulations. They protect your business from financial mismanagement—while also providing a foundation for sustained success and investor confidence. Now is the time to create or evaluate your controls to ensure they meet the demands of SOX compliance. Paro’s financial controllers have extensive public-company experience and expertise. They can take on building your company’s compliance framework, establishing and managing internal controls or implementing new technology solutions to help position your business for long-term success.
