Financial Controls Definition

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 risksFinancial RisksFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy.read more, complying with fiduciary duties, corporate governance, and due diligence requirements, and achieving financial goals. Its absence can have an impact on budgetingBudgetingBudgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time.read more, operations, and performance.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Financial Controls (wallstreetmojo.com)

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.

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.

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 sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more, cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more, and income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more (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.

Financial Controls Processes

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

  • The first step is to assess the company’s current performance in terms of sales, profitabilityProfitabilityProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more, and cash available.The next step is to detect anomalies in budgets, financial reports, and balance sheets that could prevent the company from achieving its goals.Further, it requires correcting discrepancies and deviations in financial accounts to bring the business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company’s goals like profit generation.read more back on track.Then comes regularly updating all of the information, including resource management policies and procedures, in financial documents.The next stage necessitates a thorough examination of the organization’s operational policies, such as profitability, expensesExpensesAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital.read more, and production volume.The next phase is to improve operating standards and decision-making processes by ensuring sales, profits, surpluses objectives are met.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 –

  • Boost productivity and profitability by streamlining processes across all areas and departments of the business.Conduct frequent audits and report accurate financial data to guarantee the balance sheet, cash flow statement, and income statement are all free of errors.Direct, allocate, manage, and employ financial resources per needs, resulting in increased performance and income.Improve operational efficiency by evaluating financial data, distributing resources more efficiently, and controlling cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more.Maintain financial accountability and communication at all levels, ensuring all stakeholders comply with fiduciary responsibility, corporate governance, and due diligence obligations.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:

  • Encourage employees to communicate with one another and motivate them to adhere to the company policies for overall process improvementExamine budgets, balance sheets, and financial statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more for irregularities and take corrective measuresImprove the efficiency, profitability, and security of the business operations against fraud and theftManage financial resources, which are critical for other resources needed for the successful operation of the businessMonitor 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.

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 revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more, sales cost, gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more, operating costs, and net incomeNet IncomeNet Income formula is calculated by deducting direct and indirect expenses from the total revenue of a business.. It is the most important number for the Company, analysts, investors, and shareholders of the Company as it measures the profit earned by the Company over a period of time.read more.

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.

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 –

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.

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 requirements2. Examine budgets, balance sheets, and financial statements for irregularities3. Improve the process efficiency and profitability4. Manage financial resources and activities5. Meet financial objectives6. Mitigate financial risks and prevent fraud or theft7. Monitor and control total cash inflow and outflow

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

  • Corporate FinancePublic FinanceCost Control