Internal controls: how to ensure effectiveness

You’ve probably heard the saying, “With great risk comes great reward”, but in the corporate world this scenario can be quite the opposite, right?

In order to prevent internal and external factors from posing a threat to achieving the organization’s goals, combining risk management with internal controls is essential.

Keep reading to better understand what internal controls are and how to effectively define and test them to drive your organization’s results.

What are internal controls?

Internal controls are actions, procedures, or mechanisms that, if implemented, can act on a risk, changing its probability or impact.

There are two types of controls:

Preventive: focused on preventing an undesired result before it happens.

Detective: detect errors or irregularities that may have already occurred or are occurring at that moment.

Why are internal controls so important?

The primary benefit of internal controls is the protection they provide against unexpected risks or events. Moreover, correctly defining and executing controls also enables:

  • increasing the organization’s security;
  • improving the efficiency of operations;
  • decreasing costs;
  • reducing errors or unnecessary efforts;
  • ensuring compliance with statutory regulations and laws.

Also, demonstrating risk management efforts increases customer and stakeholder confidence, giving your organization an advantage over less prepared competitors.

Defining controls

Controls work as a guarantee to ensure that risks are at acceptable levels that do not represent a danger to the organization’s goals.

We should consider that each organization is subject to different risks, as they can be impacted differently by each of these risks depending on their follow-up.

Therefore, for controls to be defined effectively, ensure that:

  • organizational goals have been clearly defined;
  • and that potential risks have been identified and assessed.

Once the risk is known, we are able to map its main causes and the effect (magnitude) of this risk to the organization. Subsequently, it is possible to establish and implement the necessary controls to mitigate the causes of the mapped risks.

Testing controls

And now that you’ve implemented the controls for risk, how do you test or validate that they are effective?

Control testing basically seeks to confirm whether the controls were effective in mitigating the risk factors, that is, whether it was possible to transform the raw risk into a residual risk in line with the organization’s risk appetite.

Please note:

Risk appetite: it is the acceptable level of risk that the organization is willing to take in the process of achieving its goals.

Prioritize control tests

For an organization with hundreds or even thousands of internal controls, testing them all would be impractical, right?

That’s why it’s important to analyze each control and determine its effect on the organization. Then, determine the nature and frequency of the tests that must be conducted.

Depending on the regulations or compliance standards that are applicable to the organization (such as SOX, GDPR, HIPAA, or PCI), the testing process and controls that are critical for testing must follow these guidelines.

Test types

Efficiency test (design)

With a more limited scope, this type of test aims to determine if the control is effectively designed to mitigate the risk factor.

Most commonly used by the first line of defense: the owner of the control or the employees who work daily in this area assess the control’s effectiveness.

Efficacy test

With a broader scope, this type of test aims to assess within a certain period if the control is being performed according to the requirements used when planning/designing this control.

Most commonly used by the second line of defense: internal auditors.

Conclusion

We can say that a control is effective when it manages to reduce or manage the risk it is intended to modify, that is, when:

  • it’s properly designed to handle the corresponding risk;
  • it addresses most/all of the risk;
  • it works as expected (reliable);
  • it operates at the right time and quickly enough.

Monitoring and reassessing internal controls with the appropriate frequency will help you plan and prioritize risk management actions and make better decisions.

Now that you’ve learned more about internal controls, how about meeting SoftExpert GRC?

A corporate governance, risk and compliance management software that enables organizations to effectively integrate business strategy execution with compliance and risk management practices.

Meet SoftExpert GRC

 

    Bruna Borsalli

    Author

    Bruna Borsalli

    Business Analyst at SoftExpert Software, holds a Bachelor's degree in Chemical Engineering from Univille. Experienced in EHS (Environment, Health and Safety) and a Quality Management specialist as well as a certified Six Sigma Yellow Belt and Internal Auditor for ISO 9001 | 14001 | 45001 Integrated Management Systems.

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