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How safe are you from employee theft? Embezzlement can carry a higher price tag at a small business than at a Fortune 500 company As an audit firm, we are occasionally engaged to help reconstruct business records in the wake of employee theft. Small businesses are particularly vulnerable to internal theft from that trusted employee - a bookkeeper, sales clerk or office manager. In one recent case, the engagement involved a small retailer with about six sales people. In this small store, there were no secrets - each employee knew the others' cash register codes. One clerk gradually began embezzling by taking cash that was documented as a sales return. Because the clerk cleverly scattered these fictitious payouts for returned goods over various shifts, using all six employee codes, the owner never spotted the problem, even though the volume of refunds continued to grow. The embezzlement didn't become evident until the dishonest employee took a two-week vacation, and refund payouts came to a screeching halt. Fortune Small Business, in its May 2002 issue, recounted another case involving a bookkeeper for a small nine-person manufacturing business. The bookkeeper was doing it all: paying the bills, posting the ledgers, and reconciling the bank statement. When her personal finances got tight, she used a company check to pay off her $700 credit card bill. She was able to hide this transaction by posting the entry to the company's books as a payment to one of its regular suppliers. Having gotten away with it once, over the next seven years she wrote 88 company checks - totaling about $250,000 - to cover her personal obligations. She was able to hide this activity because each month, when the bank statement came in the mail, she was there to remove the checks written for her personal bills. Unfortunately for her, one month she extended a vacation by several extra days. When the bank statement arrived early, the owner spotted one of canceled checks that she had written for her benefit. Fortune Small Business points out an alarming statistic about small-business vulnerability: At companies with fewer than 100 employees, the average employee theft is $120,000, versus just $10,000 at Fortune 500 companies. Solutions. One of the fundamental accounting principles to prevent misuse of company funds and embezzlement is the segregation of duties. For example, assigning to separate employees the handling of cash and the keeping of cash records can effectively require two people to collude before theft can occur. But in small companies, where one person often has total responsibility for collections, disbursements and recordkeeping, how does an owner establish internal controls that remove any opportunity for embezzlement? Mandatory vacation. In both examples recounted above, there was a common outcome: an employee's vacation allowed the misconduct to surface. Many businesses have mandatory vacation policies, not only to assure that everyone's batteries get recharged, but also to enforce the absence that can allow check kiting, delayed postings, or other patterns of financial abuse to surface. Bank statements. Another key issue involves the monthly bank statement. Receipt and reconciliation of the bank statement should be segregated from employees involved with the daily transactions and disbursements. In a small business with few employees, where this type of segregation can be difficult, a good mechanism is to have the bank mail the statement directly to the owner's residence. The canceled checks and other transactions can then be reviewed, with the statement later brought back to the office for reconciliation and any additional postings. Other issues. There are many other sensitive areas, such as properly documenting refunds, controlling employees' ability to adjust customer accounts receivable, and guarding against "phantom invoices." Recognize that solid internal controls are simply good business and should be a part of any well-run operation. A proper system of checks and balances is primarily a preventive tool, assuring that no current or future employee is put in a position of undue temptation with respect to company funds. If you are a small business owner and your internal controls could use review, we can be of assistance. 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. |
