Protect Your Firm from Internal Theft

Your kitchen and bath firm has been in business for a while and you’ve grown to the point where you have hired some help. Your strength is design or project management, so you have turned all of the drudgery of the administrative stuff over to the new office manager/bookkeeper. You are confident that you are a good judge of character and are sure that this person is completely honest.

Then one day you realize that your numbers don’t seem to be adding up. What happened?

As all too many business owners have found out the hard way, even otherwise honest people may yield to temptation if placed in the wrong position and under enough pressure from personal circumstances. It is for this reason that all businesses, particularly small businesses, must adopt sound internal control practices.

Our businesses are most vulnerable when we first begin to add staff. For many of us, our first love is designing and selling projects and our first outside employee is a bookkeeper. We immediately turn over all of the “accounting” functions including invoice processing, check writing, bank deposits, bank reconciliations, payroll, etc. so we can concentrate on the “real reason” for our business.

In a small organization, it is normal to trust that basic human integrity will keep a person from abusing this position to steal from our business. And, in the vast majority of cases, this trust is well founded. The problem is that we have placed this person in a position where the temptations are great and control is lost.

 

Internal Controls

The term “internal control” seems like it should be a term that relates to large corporations rather than small businesses. It is, in fact, simply the establishment of procedures that makes it more difficult for those either inside or outside of a business to steal from it.

The basic tenet of internal control is a separation of duties within an organization so that it would require two or more individuals colluding in order to misappropriate assets from the business. This, along with procedures for monitoring and reporting practices designed to immediately bring to light any discrepancies in cash or inventory balances, will greatly reduce the risk of loss.

 

When Money Comes In

The first situation is the handling of cash coming into our business. We will receive cash in two forms – actual currency and checks. Of the two, currency presents the most danger. Since checks are normally made out to our company, it is much more difficult (though not impossible) for an employee to convert them to their own use.

If at all possible, have someone other than the individuals preparing invoices and contracts take currency from customers. If your business takes in any significant amount of currency, you should look into the use of cash registers, pre-numbered invoice forms and separation of cash receipts and banking functions. The actual procedures for such control functions are beyond the scope of our discussion here, but if your business handles many currency transactions, you should discuss these procedures with your outside accountant.

Most of our businesses tend to have sales of substantial amount and receive payments primarily in the form of checks made out to our business name. While this makes it difficult to convert such funds to personal use, it is not impossible for an employee to set up bank accounts at another bank in the company’s name and gain control of the funds.

To safeguard against this, checks should be stamped immediately upon receipt with a restrictive endorsement stamp indicating the company’s bank, branch and account number. Invoices and contracts should go to a separate individual from the person doing the banking. Reconciliation of these sales amounts to the bank deposits should be made regularly.

 

When Money Goes Out

There are usually several ways that a business makes payments. There usually is a petty cash fund used to pay for minor/urgent expenditures, company checks and company credit cards.

The petty cash fund is probably the most likely place for employee theft to occur if more than one individual has access to the cash. Make sure that only that individual has access to and is responsible for this fund. The fund should be reimbursed only after it has been reconciled and supporting documentation has been reviewed by another responsible individual.

Unless your business issues an extremely large number of checks you, as the owner, should be the one to sign them. It is likely, however, that you will need to have an additional person authorized to sign checks in your absence. This person should be a trusted individual who does not have accounting responsibilities such as approving invoices, reconciling the bank account or ordering of materials. Additionally, blank checks should be kept secured, as banks seldom actually check the authenticity of check signatures.

If your company allows employees to have company credit cards, it is important that each such employee has a separate card number so that transactions can be associated with that individual and each statement is reviewed by you or a supervisor to make sure that these charges are appropriate.

 

Purchasing

Another area where we are exposed to the risk of employee dishonesty is in the purchasing of materials. If an employee has the authority to both order materials and approve invoices for those orders for payment, it becomes very easy for such an employee to divert material (or labor) purchased by the company to his or her personal use. The easiest way to separate this function is through the use of purchase orders, with the person ordering issuing the purchase order and someone else matching the purchase order with the vendor invoice to approve it for payment.

 

Common Sense Steps

Since many of our businesses do not have the number of responsible individuals to truly separate all of these functions, we are normally faced with at least some weaknesses in our internal control structure.

You should be aware of your cash flow and monitor it on a daily basis, making sure that the amount of cash coming in and checks going out make sense based on projected receipts and disbursements.

Have a non-accounting department person pick up the mail and bring it to you to look through before it is distributed within the company. Watch for any mail/invoices from suppliers you do not recognize.

Be aware of areas of exposure from weak internal control points and watch for problems. Be aware that if you have placed an employee in a position where internal control is weak, you are placing them in a situation where there is great temptation. In such a situation, outside pressures, such as personal financial strains, can push an otherwise honest individual over the line.

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