When I was young, I worked with my Dad in his CPA firm. Interestingly enough, some of his most heart wrenching and interesting jobs were in helping small business owners prevent embezzlement by implementing internal accounting controls.
I couldn’t believe how frequently this sort of thing was happening. I’d go in with him, listen to the business owners voice their concerns about a bookkeeper, a controller, or even a CFO.
Then, I’d then watch my dad methodically lay out a plan to either catch the person who was embezzling or prohibit it from happening ever again.
Small businesses make up the backbone of our economy and can be a lot of fun to work in, but they also create an opportunity for fraudsters and embezzlers to work undetected. The statistics are alarming: Hiscox reports that 68% of embezzlements occur at small businesses (those with fewer than 500 workers).
This is a real threat, with the average loss sitting at more than $350,000. And even if you do catch the culprit, it’s rare to recover the full amount. It’s not just about the money: you can also lose customers, business partners and suffer reputational damage.
Now that I have my own small business, a digital marketing agency, I have started to realize just how important it is to remove all temptations for someone to try and “skim a little off the top.”
While larger businesses might take these losses on the chin, many small businesses like mine would be forced to close.
Small businesses are especially vulnerable because they often don’t have the resources or knowledge to implement effective internal accounting controls. This is made more difficult by the wide number of bad practices you need to defend against:
- Billing Fraud – Fraud involving invoices. For example, the creation of fake vendors and invoices or the duplication of real invoices which use the fraudsters bank details to receive payment.
- Theft of Cash and Stock – This is when employees remove small amounts of cash or stock daily or weekly. Over a sustained period of time this can snowball to become a significant loss. Examples include a cashier stealing from a till or an office worker who regularly dips into an unregulated petty cash.
- Fraudulent Payroll Practices – This can include paying unworked hours, extensive overtime, and even the creation of fake workers for the purposes of channeling more money into a personal account.
- Expense Fraud – Fraudulent expense behavior. For example, an executive may use a business credit card to pay for personal expenses.
Your business culture can also play a part. As a small business, there may be opposition to the controls and procedures needed to protect your business. Small businesses are often built on trust, but this isn’t enough to ensure long-term success.
So, what can you do about it? Let’s take a look…
9 Internal Accounting Controls That Will Help Your Business Prevent Embezzlement
We recommend you implement the following internal controls to protect your business:
Control 1: Separation of Duties
Small businesses are frequently vulnerable to embezzlement because too many duties get concentrated in just one or two employees. For example, when the same person both writes and signs the checks without any oversight, there is a clear opportunity for misuse.
Where possible, functions such as bookkeeping, deposits, and reporting should be done by different employees. This makes embezzlement harder, but not impossible. Embezzlement involving multiple employees is not uncommon, so you still want to retain some oversight over what is going on even once you have started using separation of duties.
Control 2: Controlling Access
Don’t make it easy for employees to start embezzling. Unrestricted and untracked access to your company’s assets makes it much easier for someone to cover their tracks. Restrict employee access to money, data, computers, and inventory to only what is strictly necessary for their role and put controls in so that access is tracked and recorded.
Control 3: Standardized Procedures and Documents
Create standard procedures, document them, and then insist everyone follows the process. A solid paper trail reduces the opportunity for embezzlement and acts as a good preventative measure: employees can see you’re serious about tracking what goes on in your business.
Control 4: Regular Audits
Regularly auditing your accounts and stock increases the likelihood of embezzlement being caught early and reduces your potential damage. Ideally, audits should be carried out randomly with no notice. This is a huge deterrent to a would-be fraudster because it makes it very hard for them to hide their activity.
Remember: to be effective, the auditing must involve employees who do not carry out the everyday functions that are being checked. Otherwise, it makes it easy for someone to cover their wrongdoings.
Control 5: Review Payroll
Payroll is a key area for embezzlement. Examples include overpaying overtime and creating false employees to funnel money. You or another director should review payroll each month before it goes out to check that it is at the expected level. You can also reduce the opportunity for embezzlement by using direct deposit for payroll at all times.
Control 6: Expenses Policy
Expenses is another weak area. Create and insist on a rigorous expenses policy. Employees should provide a receipt for every expense and have an authorizing signature from their line manager. I have alerts on every single credit card so that I can keep an eye on rogue charges that haven’t been approved.
Control 7: Cash Flow Projections
A cash flow projection is a good defense against embezzlement. By predicting what you are expecting to come in and out in the future, you then have a model against which you can compare.
If reality does not match up to your prediction you should investigate and find the cause: check bank statements, invoices, and sales – were your predictions wrong or is there a problem somewhere? This good practice will also help you spot many other problems in your business.
Control 8: Insist on Holiday
Embezzlers often appear to be model employees: they come in early, work late, and rarely take holidays. But this dedication to their role isn’t because they love their job: it’s because they fear getting caught.
Enforce employee holidays and make sure every employee takes off at least one week each year in its entirety. Not only will this deter employees from embezzlement, but it will also have a beneficial effect on any other workaholics on your teams.
Control 9: Background Checks for Employees
You should check every other employee you hire, but especially those who will have any access to or influence over your finances. Where possible, use any and all legal avenues for checking the background and trustworthiness of potential candidates. Look out for warning signs such as convictions for theft or gambling, or for terminated contracts at previous places of employment.
There’s obviously many more things that you could do as a small business owner to prevent embezzlement, but implementing these nine internal accounting controls should make it a lot harder for a person to get started and get away with the loot.