Can Fraud Happen in Your Business?

Can Fraud Happen in Your Business?

Many of us have started our businesses from "scratch," beginning with only a few people. In cases like this, you, as the owner, most often made every decision, ordered all of the materials, looked at every document and signed every check.

In this sort of situation, the concept of internal control is not really relevant. However, as your business grows, you hire more people, and that means turning over some of these tasks to others.

It's at this point, when your staff first starts to grow, that your business is most vulnerable. For most of us, it's hard to imagine that anyone we know and work with daily would steal from us. We look on the small group of employees as our "family," and want to trust them.

But the sad truth is that a rare few of these trusted "family members" will prove that our faith in them has been misplaced. The question, then, is what can we do to protect ourselves without taking actions or setting up situations that will destroy employee morale?

There are two key elements to the solution: staying involved in all aspects of your business, and separating duties.

This month, we will look at these in terms of three key areas: when money comes in, when money goes out and control of materials.

Money comes in
Money normally comes into your business in two forms (excluding credit cards): currency or check. The most difficult to safeguard and control is currency, since there is normally no way to trace its path.

Most systems for controlling cash received in a business involve creating some sort of receipt record while the customer is still present. The idea is to avoid leaving any employee alone with cash until it has been "logged" in.

But most kitchen and bath firms deal with contract sales, where payments come in by check. While these checks are made out to the business, it's not impossible for people to establish bank accounts in the company name, deposit the checks and then transfer the money to their own account.

To reduce the chances of this happening, you should first make sure that checks received into the business are immediately endorsed by means of a stamp containing the name and account number of your company's bank account.

Here, especially, you must separate the handling of checks and cash from the accounting for it. Whenever possible, the person who prepares the bank deposit should not be the one who reconciles bank accounts. You or another member of your management who is familiar with the company's sales and operations should also monitor cash flow to make sure that known cash receipts actually reach the company's accounts.

Money goes out
Most of our businesses have a petty cash fund with which we take care of incidental expenditures. It's important to assign responsibility and accountability to a specific individual for such a fund. Make sure that only that individual has access to this fund, and that the fund is reimbursed only after it has been reconciled and supporting documentation has been reviewed by another responsible individual.

From a dollar standpoint, most of the money that leaves your business goes out in the form of com-pany checks. The safest way to deal with checks is to have only yourself sign checks, but this is usually not practical, and it's convenient to have additional individuals available to sign checks when you're not around. This second individual signer should be someone who can be trusted, and someone who does not reconcile the bank accounts.

One method of ensuring that unauthorized checks are not negotiated on your account is to require that each check be signed by two individuals. An alternative would be to safeguard the checks. Most banks don't really pay much attention to who has signed a check, and will process a check regardless of who's signed it. What this means is that it's very important to control access to your check forms, making sure that they cannot be used by unauthorized individuals.

If you don't perform the bank reconciliations yourself, you should, at the very least, review them, making sure that all checks are accounted for and that they are mathematically correct.

A business can also be defrauded by the misappropriation of other assets, such as the diverting of construction materials. There are several ways to accomplish this, including issuing purchase orders for materials that do not wind up on company projects, even though they indicate valid job information.

You can protect yourself against this by utilizing a purchase order system with pre-numbered purchase order forms, making sure that all the numbers are accounted for.

You should also inform all of your suppliers that purchase orders are required, and that only certain individuals are authorized to place orders.

You also need to have a clearly defined tool policy to prevent against theft. Small tools should be assigned to specific individuals, and larger ones should be controlled through a check-out program.

General tips
Most fraud occurs in small businesses that lack the sophistication of control procedures and the ability to separate functions the way that larger businesses can.

Some common sense tips for prevention include the following:

  • Remember that most embezzlements occur over a long period of time, with a constant stream of small amounts of money leaving the business. Over time, this can easily turn into several thousand dollars or more.
  • Be careful of placing people with significant financial problems in positions where fraud can occur. Even otherwise honest people can be pushed over the edge by financial pressures. It's prudent to run credit checks on potential hires who will be working in sensitive positions.
  • Make sure that all employees with any kind of financial or purchasing responsibility take their annual vacations. Be leery of the "dedicated" employee who never takes a day off.
  • Be particularly vigilant if your business is facing downsizing with layoffs on the horizon.

Most of us will go through our entire business careers without having to deal with a major fraud, but almost all of us will have to deal with at least some episode of employee dishonesty. Establishing sound internal control procedures is the best means of protecting your firm against fraud.