Financial controls consist mainly of financial statements, ratio analysis, and comparative financial analysis. The primary financial statements are the balance sheet and the income statement. Managers or entrepreneurs need to guard against major pitfalls associated with financial controls.
Financial control, therefore, entails the use of quantified measures to monitor deviations.
A financial statement is a summary of the major aspect of an organization’s financial status. The information contained in such statement is essential for the entrepreneurs in maintaining financial control over organizations.
Two basic types of financial statements typically used by business organizations are the balance sheet and the income statement. Financial statements are typically prepared at the end of reporting periods, such as quarterly and annually.
Balance Sheet is a financial statement that shows an organization’s assets and (liabilities) claims against those assets at a given point in time.
- Assets: An asset is something of value that is owned by the business. Assets are made up of three components: fixed assets, currents assets, and intangible assets.
- Fixed Assets: These are the tangible resources or assets, which are used in the operation of the business for revenue generation. They have a useful life that exceeds one year such as furniture and fittings, buildings and vehicles.
- Current Assets: These consist of cash and other assets that are usually converted to cash which are used within 1 year, (g., cash, inventory or stocks and accounts receivable or debtors).
- Intangible Assets: These are made up of assets that cannot be seen by our physical eyes but adds value to the business (g., are copyright, patents, goodwill, licenses, etc).
- Liabilities: Liabilities are claims by non-owners against company assets, in other words, debts owed to non-owners, such as banks. Liabilities also fall into two categories: current and long-term.
- Current Liabilities: These are accounts that are typically paid within one year (such as accounts payable-current bills the company must pay and short-term loans). Long-term liabilities are debts usually paid over a period that exceeds one year.
- Shareholders’ Equity: This represents by owners against the assets. As you might expect, shareholders’ equity is equal to the company’s assets minus liabilities. Shareholders’ equity is, in essence, the organization’s net worth.
The second segment of the financial statement is the income statement otherwise known as the profit and loss account. An income statement shows the financial summaries of the operations of the business as revenues and expenses.
Revenues are the assets derived from selling goods and services. Expenses are the costs incurred in producing the revenue (such as costs of goods sold, operating expenses, interest expenses, water, rent, insurance, and taxes).
Source Documents (invoice receipts, bank tellers, etc) -> Subsidiary Books (Purchases/Sales Day Book) -> The Ledger (Debtors, Creditors, and General Ledger) -> Financial Reports (Balance Sheet, Income Statement)
Record keeping is an accounting which is concerned with the generation of information, while financial report statement is an accounting function concerned with the interpretation of the information generated. Record keeping can also be called bookkeeping.
The documents that evidence the transactions (invoice, a bill, a receipt, a loan indenture, etc.) usually called Source Document are used to record information in the book of record. These books of record or book of accounts are called subsidiary books.
The two most important books of record are the sales and cash receipts book or journal, and the purchases, cash disbursement, and expense journal.
Sales and cash receipt journal is used to record daily income business, the sales day book or journal credit sales, while the cash receipt and journal records payments in cash, the sum of the credit sales and cash sales, give the total sales for each day/period and this is the amount used in the income statement.
Purchases, cash disbursement, and expense journal record the expenditures of the business. The purchased book is used for recording material purchases. The expenses journal, on the other hand, is used to record all payments for expenses incurred e.g., overheads; (administrative costs, rent, electricity bills, insurance, salaries, direct labor, etc).
The Ledger: Here all the data summarized in the subsidy book are posted into the ledger which is the main book of accounts. Ledger can be subdivided into debtors (sales) ledger, creditors (or purchase) ledger, and the general ledger.
The debtors’ ledger is used to record accounts of individuals and companies to whom goods and services were sold on credit. That is, it is used to record credit sales or the debtors.
The creditors’ ledger, on the other hand, is used to record accounts of individuals or firms from whom goods are bought on credit (that is, it is used to record the names of our creditors) while the general ledger is used to record accounts of the assets, income, and expense of the firm.
A trial balance is a listing of the ledger accounts, with their totals or balances, shown columns of debit and credit. The totals of the debit and credit columns are expected to agree if the accounts have been correctly kept under the double-entry principle. If they do not agree, then it suggests that there could be one or more errors in the ledger. After the correctness of the ledger is checked by the trial balance and in conjunction with the subsidiary books, revenues expenses and changes in balance sheet accounts can be determined and financial statements drawn up.
The ratio is an index that measures one variable relative to another, and it is usually expressed as a percentage or a rate. In assessing the significance of various financial data, entrepreneurs often engage in ratio analysis, the process of determining and evaluating financial ratios.
Pour types of financial ratios are particularly important to managerial control: liquidity, asset management, debt management, and profitability ratios. Liquidity ratios are financial ratios that measure the degree to which the organization’s current assets are adequate to pay current liabilities (current debt obligation). A major liquidity ratio is a current ratio, which measures a company’s ability to meet the claims of short-term creditors by using the only current asset.
Asset management ratio (sometimes called activity ratio) measures how effectively an organization manages its asset. One of the most used asset management ratios is inventory turnover.
Inventory turnover helps measure how well an organization manages its inventory. How inventory turnover may point to either excess or obsolete inventory. High inventory turnover generally signals effective handling of inventory relative to selling patterns because less money is tied up in inventory that is waiting to be sold.
Debt management ratios (often called leverage ratios) assess the extent to which an organization uses debt to finance investments, as well as the degree to which it is able to meet its long-term obligations. One of the most important ratios is the debt ratio, which measures the percentage of total assets, financed by debt (including current liabilities).
Profitability ratios help measure management’s ability to control expenses and earn profits through the use of organizational resources. Two commonly used profitability ratios are Net Profit Margin and Return On Investment (ROI).
Some Financial Control Pitfalls
While financial control can be extremely helpful to top management, there are six primary pitfalls that affect their usefulness:
- Implementing financial controls that are too sophisticated for organizational need.
- Allowing financial controls to deny innovations and creativity in the organization.
- Failing to tailor financial controls to the specific requirements of the organization.
- Neglecting to link financial controls to the strategic planning process.
- Instituting controls that send a mixed message about desired behaviors.
- Forcing the same financial controls and various subunits that have different control requirement.
Internal Financial Controls for SMEs
Many entrepreneurs fail in their business not because of lack of patronage but because of lack of adequate financial controls. Some entrepreneurs do not properly control the receipts and disbursements either because of lack of accounting knowledge.
Seven key areas of proper checks and controls have been enumerated with guiding questions for the entrepreneur’s comprehensive.
These questions are suggested to be answered by entrepreneurs about financial control of their business:
- Are your financial records truly accurate?
- How well are you managing the financial aspects of your business generally?
- Are your business operations protecting you against disasters, internal theft, and unfavorable external audits?
Owners of well-managed Small and Medium Enterprises (SMEs) would answer, “yes” to most of the following questions:
- Does the owner understand the form and contents of the financial statement?
- Does the owner use budgets and cash projections?
- Are they compared to actual results?
- Are major discrepancies investigated?
- Are comparative financial statements produced?
- Are the books and records kept up-to-date and balanced?
- Is a chart of account used?
- Is it detailed enough to give adequate management information?
- Is a double entry bookkeeping system used?
- Who approved journal entries?
- Who is responsible for producing financial information?
- Is the owner satisfied that all employees are competent and honest?
- Are job reference checked?
- Is there a records retention schedule used?
- Are reasonable due dates imposed?
- Is staff cross-trained in accounting functions?
- Are annual vacations required?
- Are storage facilities safe from fire etc?
- Is access to accounting records restricted when appropriate?
- Are employees bonded?
- Is insurance coverage regularly reviewed?
- Is accounts receivable subsidiary by ledger balanced monthly to control account?
- Is an aging schedule of customers’ accounts prepared monthly?
- Are write-off and other adjustments to customer accounts authorized by the owner?
- Is there a policy for credit approval?
- Are credit files kept current?
- Are credit checks done regularly?
- Are sales orders approved for (i) price, terms, (iii) and accounts balance limits?
- Are all sales orders recorded on pre-numbered forms and are all numbers accounted for?
- Are sales invoices compared to receiving documents?
- Are sales invoices recorded promptly?
- Are credit means pre-numbered, accounted for and approved?
- Are monthly statements for outstanding balances reviewed by the owner? Mailed by the owner or responsible employee other than the bookkeeper?
3. Cash Receipts
- Does the owner or a responsible employee other than the bookkeeper or person who maintains accounts receivable:
- Open the mail and pre-list all cash receipts before turning them over to the bookkeeper?
- Stamp all cheques “for deposit only” before turning them over to the bookkeeper?
- Compare daily pre-listing of cash receipts with:
- Cash receipts journal?
- Duplicate deposit slip?
- Are cash receipts deposited intact on a daily basis?
- Are cash receipts posted promptly to appropriate journals?
- Are cash sales controlled by cash registers or pre-numbered cash receipts forms?
4. Cash Disbursements
- Are all disbursement except for petty cash made by cheque?
- Are cheques pre-numbered and all numbers accounted?
- Are all cheques recorded when issued?
- Are all unused cheques safeguarded with access limited?
- Is a mechanical cheque protector used to inscribe amounts as a precaution against alteration?
- Are voided cheques retained and mutilated?
- Are all cheques signed by the owner?
- If a signature plate is used, is it under the sole control of the owner?
- Are supporting documents processed invoices, receiving reports, purchase orders, presented with the cheques and reviewed by the owner before he signs the cheques?
- Are supporting documents for cheques properly canceled to avoid duplicate payment?
- Are cheques payable to cash prohibited?
- Are signed cheques mailed by someone other than the person who writes the cheques?
- Are bank statements and canceled cheques:
- Received directly by the owner?
- Reviewed by the owner before they are given to the bookkeeper?
- Are bank reconciliations prepared:
- Monthly for all accounts?
- By someone other than the person authorized to sign cheques or use a signature plate if they are other than the owner?
- Are bank reconciliations reviewed and adjustments of the cash accounts approved by the owner?
- Are all disbursements from petty cash funds supported by approved vouchers?
- Is there a predetermined maximum naira limit on the amounts of individual petty cash disbursement?
- Are petty cash funds on an impress basis and
- Kept in a safe place?
- Reasonable in an amount so that the fund ordinarily requires reimbursement at least monthly?
- Controlled by one person?
- Periodically counted by someone other than the custodian?
5. Accounts Payable
- Are vendor invoices:
- Matched with applicable purchasing order?
- Matched with applicable receiving reports?
- Reviewed for the correctness of:
- Quantities Received?
- Price Charged?
- Clerical Accuracy?
- Account Distribution?
- Are all available discounts taken?
- Is there written evidence that invoices have been properly processed before payment, e.g., stamped?
- Are there procedures, which provide the direct supply to customers, if any, are property billed to them?
- Does the owner verify that the trial balance of accounts payable agrees with the general ledger control account?
- Are expense reimbursement requests:
- Submitted properly?
- Adequately supported?
- Approved before payment?
- Are all materials inspected for condition and independently accounted, measured, or weighed when received?
- Are receiving reports used and prepared promptly?
- Are receiving reports subjected to the followings:
- Pre-numbering and accounting for the sequence of all numbers?
- Copies promptly provided to those who perform the purchasing and accounts payable function?
- Controlled so that liability may be determined for materials received but not yet invoiced?
- Are all employees hired by the owner?
- Are individual personnel files maintained?
- Is access to personnel files limited to the owner or a designee who is independent of the payroll or cash function?
- Are wages, salaries, commissions, and piece rates approved by the owner?
- Is proper authorization obtained for payroll deductions?
- Is gross pay determined using authorized rates?:
- Adequate time records for employees paid by the hour?
- Piecework records for employees whose wages are based on production?
- Are piecework records reconciled with sales record?
- Are the salesmen’s commissions records reconciled with sales records?
- If employees punch time clocks, are the clocks located where they may be watched by someone in authority?
- Are time records for hourly employees approved by a foreman or supervisor?
- Is the clerical accuracy of the payroll checked?
- Arc payroll registered, reviewed by the owner?
- Does the owner approve, sign and distribute payroll cheques?
- If employees are paid in cash, does the owner compare the cash requisition to the net payroll?
- Does the owner maintain control over unclaimed payroll cheques?
These above information are the key points to help the entrepreneurs have adequate control over the internal finance of their organizations.
In order to ensure greater efficiency and attainment of the organizational goals, entrepreneurs should endeavor to follow the control techniques dutifully if the finance of their businesses is to be properly and adequately be controlled.
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