Examples of Internal Controls for Balance Sheets


Internal controls are becoming more important as firms try to mitigate increased levels of risk. This risk is created by data and information flow. Information technology has allowed many companies to automate processes; however, it also created a greater need for control over that information. The three most common controls used by organizations are financial statements. This includes the balance sheet, income and cash flow statement. There are some companies that may gain greater control over processes by monitoring and creating controls for the balance sheet.

The Equation

The best feature about a balance sheet is that it's really one big equation. The equation is Assets = Liabilities + Net Worth. All balance sheets follow this same balancing rule. When this equation does not work, it's a good indication that something is out of balance, which makes the equation an ideal control.

Current Ratio

The current ratio is a test of financial strength. It tells you how many dollars in assets can be converted to cash in the current period (approximately three months). It is also used as a measure of liquidity by bankers. The ratio is computed by dividing current assets by current liabilities. If a company has $5 million in current assets and $10 million in current liabilities, the current ratio is .5, which is poor. A ratio of 2 is ideal.

Operational Efficiency

Activity ratios focus on how well the company is managing the operating cycle. Comparing them can give good insights into the operational efficiency of a firm. For a company that holds inventory, an effective control is the inventory turnover ratio. This is the "costs of good sold" / "average inventory." If your "costs of good sold" is $10 and the average amount of inventory held is $5, then your inventory turnover ratio is 2. This means your inventory turns over two times with each item sold. Higher ratios are generally better.

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