Article: Preventing Embezzlement


	Lynn Westergard

Preventing Embezzlement

Preventing employee theft requires that you hire honest people, employ tight internal controls, and be a good boss

As much as you may want to believe that "It can't happen to me," the sad truth is that if you have employees, you are a potential victim of embezzlement.

Embezzlement can strike any company, at virtually any level: purchasing, bookkeeping, payroll, contract preparation, sales. No employee-controlled aspect of your business is immune. Worse yet, embezzlement seems to be on the rise, especially in companies whose owners cling to inadequate security procedures and unrealistically assume that all of their employees are completely honest.

Types of embezzlement. Embezzlement can take as many forms as there are functions in your company.

Cash receipts. An employee can pocket the money received from a customer and then cover the shortage by pulling money from other accounts. Or a cashier can sell merchandise and, instead of recording the sale and putting the money in the cash register, steal the money and fail to issue a customer receipt.
Banking. Check floating or kiting can occur when an employee has access to two or more bank accounts.
Payroll. Payroll fraud can occur if checks are issued to fictitious employees and cashed by the person who wrote the paycheck.
Purchasing. A dishonest employee with purchasing authority can issue phony invoices to vendors and then pocket money that your company paid for undelivered goods or services.
Expense reimbursement. Look out for receipts for untraveled mileage, personal telephone calls, meals, and entertaining "potential customers."

Causes

As vulnerable as you may seem to employee dishonesty, you can protect yourself, especially if you understand the common causes of embezzlement:

Financial need, perhaps due to alcoholism, drug abuse or gambling.
Opportunity made possible by your loose internal controls.
Rationalization evolving out of the employee's belief that, due to undercompensation, overwork, or length of employment, he or she is "owed" the money.
Employee mistreatment, which - whether real or imagined - can cause employees to seek revenge or otherwise hurt you and your company. Your "offense" may be as benign as failing to recognize achievement or longevity.

Warning signs

Be alert to conditions that may signal the potential for embezzlement:

Close relationships with suppliers. Excessive familiarity, gifts or entertainment may interfere with purchasers' resolve to drive hard bargains. Worse, they may result in "phantom" purchases, with payments split between employee and supplier.

Close relationships with customers. Dishonest employees may try to cultivate kickbacks from customers seeking a better deal.

Odd behavior. Look out for employees who are slow to provide accurate financial information; who won't let anybody review their paperwork; who decline promotions to other positions; and who never are absent or never take vacations (out of fear that they will lose the ability to cover their tracks).

Financial difficulty. Look out for employees who frequently ask for pay advances or try to borrow money from fellow workers.

Co-worker complaints. Random snitching by one or two co-workers may simply indicate personality problems or incompatibility. But consistent words of warning from reliable employees may be worth heeding.

Living beyond means. How can your unmarried, $30,000-a-year bookkeeper afford that Lexus?

How to prevent embezzlement

Hire honest people. In most cases, embezzlement tends to be committed by employees who were dishonest before they were hired. Therefore, you should thoroughly investigate the backgrounds of every applicant.

Insist that applications be complete and legible, and verify every important piece of information.

Follow up on references and talk to former employers.

Check for criminal convictions.

Use credit checks to discover if an applicant has financial troubles. (This requires written authorization by the applicant.)

Conduct pre-employment testing that may reveal dishonesty.

Be a good employer. Implement an open, participatory management style. Pay adequately. Treat your people fairly. Reward achievement.

Have sound internal controls. Completely separate the accounts payable from the accounts receivable and from the cash receipts. Also:

Separate the payroll functions, with one employee in charge of preparing paychecks and another in charge of distributing them and reconciling them against an employee manifest.

Don't let the person who maintains company records also handle cash receipts.

Insist on approving all checks over a certain amount (e.g., $500.00).

Pay only from an original invoice.

Personally reconcile all bank statements promptly.

Occasionally reconcile sequential invoices, receipts and other forms.

Hire an expert to help you guard against computer-related embezzlement.

Run random spot checks. For example, periodically have a non-payroll employee distribute paychecks.

Supervise and verify. Supervisors should oversee their staffs' work and occasionally assist in handling routine transactions. Verify that paperwork is in order before signing documents to release money or goods. Have an outside accounting firm perform internal audits periodically, no less often than once per year. Finally, set a good example. Obey your own procedures and policies, and don't exhibit behavior that you wouldn't tolerate in the people who work for you.

What to do if someone's embezzling

If you suspect that an employee is stealing from you, it's important not to overreact (a false accusation could cause you far more problems than the alleged embezzlement). Here are some suggested steps:

Don't make any accusations until you have proof. Accusing an employee before you catch him "red-handed" may cause him to pursue even more nefarious methods to avoid further detection.
Ask for guidance from an experienced employment attorney. He can help you avoid counterclaims by the employee, and he can also advise you on methods of recovering pilfered money.
Hire an independent accountant to examine all records associated with the suspect's responsibilities.
Fire all embezzlers. Giving them a second chance will send a bad message to other employees.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.