Financial Controls

Updated on May 15, 2024
Article byPrakhar Gajendrakar
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

Financial Controls Definition

Financial controls refer to the development of policies and procedures by an organization to manage its financial resources and operate efficiently. It is essential for cash flow management, budgeting, and the prevention of any fraud or theft. Thus, it enables the business to track and oversee its financial activities to grow and prosper.

An organization needs to implement a financial controls framework to manage, document, analyze, and report transactions. Effective financial management planning aids the company in mitigating financial risks, complying with fiduciary duties, corporate governance, and due diligence requirements, and achieving financial goals. Its absence can have an impact on budgeting, operations, and performance.

Financial Controls

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Key Takeaways

  • Financial controls refer to an organization developing policies and processes for managing its financial resources and operating efficiently.
  • It helps a firm mitigate financial risks, comply with fiduciary duties, corporate governance, and due diligence requirements, and meet financial objectives.
  • The three finance controls, which provide a thorough and accurate financial position of a business are the balance sheet, income (profit and loss) statement, and cash flow statement.
  • It is critical for cash flow management, budgeting, and fraud prevention. Thus, it enables the company to track and manage its financial activities to grow and succeed.

Understanding Financial Controls

Financial controls enable an organization to determine the direction, allocation, and use of its financial resources. Thus, the company can make sensible spending decisions by maintaining financial accountability based on its objectives consistent with its existing situation and forecast.

This strategy involves reviewing the company’s actual performance concerning its business plans and adjusting policies and procedures in response to any anomalies, irregularities, or unanticipated changes.

In simpler words, financial controls are necessary for the formulation of strategies and policies of an organization. It not only reduces expenses but can also streamline the entire process, resulting in increased profits. The absence of it can bring chaos to the system.

Businesses typically need to keep track of and control their financial resources to fulfill their goals. The balance sheet, cash flow statement, and income statement (profit and loss) are the three most effective ways to accomplish so. It provides an insight into identifying new business prospects and fine-tuning processes to optimize performance while adhering to industry and legal standards.

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Financial Controls Processes

Steps in Financial Controls Processes

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The following is a step-by-step approach for implementing a financial controls checklist in a business:

  1. The first step is to assess the company’s current performance in terms of sales, profitability, and cash available.
  2. The next step is to detect anomalies in budgets, financial reports, and balance sheets that could prevent the company from achieving its goals.
  3. Further, it requires correcting discrepancies and deviations in financial accounts to bring the business operations back on track.
  4. Then comes regularly updating all of the information, including resource management policies and procedures, in financial documents.
  5. The next stage necessitates a thorough examination of the organization’s operational policies, such as profitability, expenses, and production volume.
  6. The next phase is to improve operating standards and decision-making processes by ensuring sales, profits, surpluses objectives are met.
  7. Finally, it requires making forecasts and setting goals for different scenarios based on the above steps, including investment and production planning.

Objectives Of Financial Controls

A company must prepare a financial controls checklist to minimize the risks, avoid future consequences, and ensure profitability. Its main objectives are –

  1. Boost productivity and profitability by streamlining processes across all areas and departments of the business.
  2. Conduct frequent audits and report accurate financial data to guarantee the balance sheet, cash flow statement, and income statement are all free of errors.
  3. Direct, allocate, manage, and employ financial resources per needs, resulting in increased performance and income.
  4. Improve operational efficiency by evaluating financial data, distributing resources more efficiently, and controlling cash flow.
  5. Maintain financial accountability and communication at all levels, ensuring all stakeholders comply with fiduciary responsibility, corporate governance, and due diligence obligations.
  6. Meet production targets, cut costs, and prevent invoice fraud through on-budget, on-target expenditure.

Importance Of Financial Controls

Any business or firm, irrespective of its size, operates under a set of principles, guidelines, and measures. There are many reasons why internal financial controls are a crucial part of strategic business planning:

  1. Encourage employees to communicate with one another and motivate them to adhere to the company policies for overall process improvement
  2. Examine budgets, balance sheets, and financial statements for irregularities and take corrective measures
  3. Improve the efficiency, profitability, and security of the business operations against fraud and theft
  4. Manage financial resources, which are critical for other resources needed for the successful operation of the business
  5. Monitor and measure total cash inflow and outflow, resulting in the process efficiency

Types Of Financial Controls

There are mainly three types of finance controls based on their purpose and target areas:

#1 – Immediate (Directional) Financial Control

It involves taking quick actions in response to discrepancies in financial reports, which if ignored can result in significant losses or undermine a company’s goals and operations.

#2 – Selective Financial Control

It concentrates on particular aspects of a company, such as management and production. It evaluates how a process operates, how it adheres to guidelines, and whether it contains flaws or margins of error. Then it employs all available metrics or makes amendments to improve performance by maximizing resource utilization.

#3 – Postdate Financial Control

It usually takes place after operations have occurred and identifies flaws in current policies and regulations. A corporation evaluates its existing strategy and performance compared to its anticipated objectives and then makes necessary changes or improvements based on the existing outcomes.

Types of Financial Controls

Aside from these, the balance sheet, cash flow statement, and income (profit and loss) statement assist organizations in evaluating their operations concerning their objectives:

#1 – Balance Sheet

It provides information about the financial success and position of the company against expectations at a particular point in time. It has two components – assets and liabilities.

#2 – Cash Flow Statement

It shows the total cash available for a business, i.e., cash received minus cash expended every month of a fiscal year. Negative cash flow necessitates a re-evaluation of corporate strategies.

#3 – Income (Profit and Loss) Statement

It depicts the relationship between business income and expenses over time. It consists of revenue, sales cost, gross profit, operating costs, and net income.

Examples

Let us look at the following financial controls examples to understand the concept better:

Example #1

Mathew wants to establish his own business and decides to produce bulbs. He has money, but he lacks financial strategy, objectives, and knowledge of operations. Mathew gets his first big order but made little profit and missed a golden chance. It happened because he had no experience in finance controls, such as resource allocation, budgeting, and cash flow management.

Example #2

Alexis is the owner of a business, and she employs skilled professionals for each department. She regularly audits to keep an eye on resource allocation, management, and output.

Alexis takes a vacation and leaves the company in the hands of her executives. She returns after a month and discovers that their subordinates have not performed as expected. Alexis examines the cash flow statement, balance sheet, income statement and finds numerous errors and inventory shortage. She instantly assumes the responsibility of financial controls and takes swift action to restore service.

Example #3

At the end of 2018, ABB found itself in an unexpected scenario when its lack of efficient internal financial controls resulted in lower incentives for several executive committee members. The audit firm KPMG discovered flaws in the books of ABB. However, ABB decided to improve its risk-identification processes by training executives and conveying control responsibilities to them. It is worth noting that the corporation lost $100 million two years ago due to financing controls issues.

Frequently Asked Questions (FAQs)

What are financial controls?

Financial controls are policies and guidelines that an organization sets to manage its financial resources and operate efficiently. It also includes a set of rules for documenting, analyzing, and reporting transactions. It enables a company to decide the direction, allocation, and use of financial resources and ensure effective financial management, production efficiency, and profitability. Budgeting, operations, and performance can all suffer as a result of its absence.

Why are financial controls important?

Financial controls are an essential component of long-term business strategy as these enable the organization to:
1. Comply with fiduciary duties, corporate governance, and due diligence requirements
2. Examine budgets, balance sheets, and financial statements for irregularities
3. Improve the process efficiency and profitability
4. Manage financial resources and activities
5. Meet financial objectives
6. Mitigate financial risks and prevent fraud or theft
7. Monitor and control total cash inflow and outflow

How to implement financial controls?

The steps for applying financial controls framework in a business are as follows:
Step 1: Assess the company’s current performance
Step 2: Detect anomalies in budgets, financial reports, and balance sheets
Step 3: Correct deviations in financial accounts
Step 4: Regularly update financial documents
Step 5: Examine the organization’s operational policies
Step 6: Improve operating standards and decision-making processes
Step 7: Make forecasts and set goals for different scenarios

This has been a guide to Financial Controls and its meaning. Here we discuss how Financial Controls works along with its process, types, and objectives. You can learn more from the following articles –

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