How Segregation of Duties Can Protect Your Business

employees holding puzzles pieces representing segregation of duties

Running a small or medium-sized business comes with its unique set of challenges. This is especially true when it comes to managing finances. One of the fundamental tools you can use to ensure financial transparency, accountability, and integrity is an internal accounting control called: Segregation of Duties (also known as SoD or separation of duties).

Let’s explore the significance of the segregation of duties including practical examples of how it works. We’ll dive into why you need a separation of duties policy, especially when dealing with cash, be it depositing cash, cash receipts, or managing petty cash. We’ll also touch upon tools that can help you such as a Segregation of Duties matrix.

What Does Segregation of Duties Mean?

Segregation of Duties is all about dividing financial responsibilities among different people or departments in your business. When you separate the responsibilities and assign more than one person to look at the process, it prevents a single individual from having too much control over critical functions. This system is a key internal control that creates a checks and balances system to reduce accounting errors, fraud, or misconduct in your financial processes.

4 Common Examples of Segregation of Duties

purchase order form representing separate roles of purchasing and approvals in internal controls

Example #1: Purchasing and Approvals

Whether you’re a small or medium-sized business owner, it’s essential that the person making purchases is not the same person approving them. Separating these roles ensures that expenses are reviewed independently and is a key process in risk management.

Example #2: Accounts Payable and Vendor Approval

The person handling payments should not be the same person in charge of approving vendor invoices. This separation ensures that invoices are thoroughly reviewed before payment.

Example #3: Cash Handling and Reconciliation

Whoever is responsible for cash should not also be the same person reconciling bank statements and other financial statements. This duty separation ensures that your financial records remain balanced without any bias.

Example #4: Inventory Management and Financial Reporting

The person you appoint to track inventory should be a different person from the one with the authority to make changes to your financial records. This duties segregation prevents anyone from tampering with your financial data.

How Segregation of Duties Protects Your Business

padlock over wallet and credit card on top of keyboard, representing business finances protection with segregation of duties controls

Effective internal controls not only help you make informed decisions for your business, but they also set up a safety net to safeguard your company’s financial health and integrity. Implementing SoD controls provides several advantages for businesses, regardless of their size. It can pose a huge risk if assigned duties aren’t split up and financial accounting systems are solely in the hands of one individual.

Here are some of the major reasons that Segregation of Duties is such an important part of its business processes.

  1. Fraud Prevention: With SoD your business sets up a protective barrier against employees that may otherwise attempt and possibly succeed in skimming or other means of theft. When you have more than one person reviewing bank statements and other financial records, you set up a hierarchy of accountability to prevent fraud.
  2. Error Detection: Employees are all human, and are bound to make mistakes. Segregation of Duties can help detect errors or irregularities that may be made in a financial process and address them in a timely manner. This also helps you to notify the employee responsible for an error so they can look out for the same issues in the future.
  3. Regulatory Compliance: Some industries require Segregation of Duties controls to meet specific regulations and standards. Examples of government standards that an organization may need to adhere to include: the Sarbanes-Oxley Act (SOX), HIPPA (healthcare industry), and the Dodd-Frank Act (financial institutions). Failure to comply with industry-specific controls puts your company at risk of heavy fines or in some cases closure.
  4. Risk Mitigation: Effective implementation of Segregation of Duties controls can help businesses reduce the risk of financial losses, reputational damage, or legal implications that may pop up from financial misconduct. A positive reputation is vital for all businesses. So it is imperative to establish appropriate quality assurance measures like recording and storing relevant documentation for any potential issues that may arise.

Use SoD for Cash Controls

one-hundred dollar bills representing internal segregated duties for cash managment

Cash management is essential for businesses of all sizes. Compensating controls are a type of control used by businesses with less resources to implement stricter SoD controls. For example, if your company doesn’t have the budget for extensive monitoring technology or additional staffing, you can implement compensating controls to minimize risks. In the case of cash management, compensating controls can be set to ensure that handling, disbursing, and reporting cash are conducted securely and effectively. Some key concepts in cash controls are authorization, job roles, and dual signatures.

First, define who is allowed to access and handle business cash. Then create separate job roles for reconciliation and reporting to prevent any single person from having excessive control over your cash operations. Additionally, implement a dual signatures policy for checks or other cash disbursements. Requiring two signatures provides you with supporting documentation for transactions to further enhance employee accountability and protect your accounts.

Petty Cash Accounts SoD Roles

Even when handling small amounts of cash, like petty cash, SoD controls are essential. When handling cash there isn’t a bank statement to check for accountability. You need a system for cash accounts that keeps a close eye on the flow. To manage petty cash effectively, assign two distinct roles to different employees.

  1. Custodian Role: A person responsible for managing and disbursing petty cash funds.
  2. Reconciliation Role: Another individual to regularly review and balance your petty cash transactions. This ensures that all expenses are properly accounted for.

Help to Implement Segregation of Duties

There are many challenges that businesses can face when implementing internal controls including SoD. Whether you’re operating a small or medium-sized business, Segregation of Duties is a powerful tool to ensure financial transparency, accountability, and integrity. Even if you understand its importance it can be quite an undertaking to implement it effectively. Here are some ways to simplify the process and get your SoD policies underway.

Segregated Duties Control Matrix

To simplify the planning of SoD controls, you can create a Segregation of Duties matrix for your business. A SoD Matrix is a document or spreadsheet that outlines roles and responsibilities within your organization. It helps you to identify which duties should be kept separate for effective internal controls. The matrix streamlines workflow and improves the efficiency of financial processes by ensuring that tasks are assigned to individuals with the necessary skills and expertise. This reduces redundancies and errors.

The matrix can also serve as a valuable resource for training new employees. It helps them understand their roles within the organization and the importance of adhering to internal controls. When employees have defined roles and responsibilities to look at, it promotes transparency. It also becomes easier for management to track who is responsible for each step of a process in turn making it difficult for unauthorized actions to go unnoticed.

Regularly update your segregation of duties matrix to adapt to changes within your business. As your business grows, the matrix can be updated to accommodate changes in roles and responsibilities. It provides a flexible framework that adapts to your organization’s needs.

Hire Professional Business Consultants

If you don’t know where to start or have questions when creating and implementing your separation of duties, the business consultants at Simply Counted can help. Contact us for a consultation. We can help you set up shared responsibilities, and transaction processing policies, as well as outline any other control activities to protect your business.

Diana Kasza

President of Simply Counted Business Services, Inc.

Diana is an Accredited Business Accountant/Consultant with more than 25 years of experience. She is a graduate of Ferris State University and an active member of Toastmasters International.

Was last modified 16 October 2023 by Diana Kasza