By Robert D. Jones, CBM, CFE In these recessionary times, our troubled economy has taken a mighty wallop to all major business sectors. From real estate, banking and automotive to retail and service, businesses, both large and small, are suffering. We hear reports every day in the media about “business bailouts” and “stimulus packages”. Powerful leaders from the automotive, finance, and banking industries lobby Congress for their share of the funds. While politicians seem to be juggling their differing ideologies to arrive at some sort of an agreement, “stimulus” funds are slow to reach Main Street. More importantly, the backbone of our economy, the small business, is targeted by both external and internal threats.
During a typical business cycle, when orders dry up and sales decline, small business owners either borrow from lenders to tide them over or trim excess overhead to keep solvent. However, the current economic troubles threaten the viability of a business more then ever before. As a result, businesses have to take extreme measures to stay afloat. Such measures include laying off key support personnel which creates internal business problems. Borrowing funds to keep afloat while accounts receivables age longer and expansion plans or capital improvements have all but dried up. In fact, massive layoffs to both blue and white collar workers reach the tens of thousands every day.
Small businesses which typically rely on streamlined office support staff are at a greater risk than ever before. As layoffs mount and sales stagnate, the small business owner must make tough economic decisions to keep on going. When office duties are no longer segregated, internal controls are breached. Normal office guidelines are no longer enforced by company management. As a result, the potential for employee misuse is very high.
As a forensic accountant and private investigator, I am routinely asked by business owners to review their books and records when fraud is suspected. In one recent case, a company that specializes in water well drilling and water pump installations, with annual revenues of approximately $10 million, suspected that one of their employees had been stealing cash. The principal was the office manager/bookkeeper. His office responsibilities included managing the accounts receivable, including depositing receipts (cash and checks) into the company’s bank account when monies were received from customers. In addition, the principal performed bank reconciliations.
Questions arose from the owners as to how cash receipts are handled after they had observed a customer giving a cash payment to another employee. This employee apparently then gave the cash payment to the principal in order to post the payment on the company’s books. The owner subsequently tried to determine whether or not the cash had been placed into the cash drawer or the petty cash box prior to its deposit.
The next day, while the principal was on vacation, the owner searched the principal’s office for the cash but was unable to find it. He then contacted their bank to determine if the cash had been deposited. The owner had been advised by his bank that no cash had deposited into this account since it had opened in the last two years.
Our firm was retained to investigate the books and records of the company including all of the business bank accounts. We immediately requested bank deposit slips for each of the business bank accounts encompassing the duration of the principal’s employment. We then compared each entry of the company’s general ledger checking account to the deposit slips. We noted several general ledger entries identified as cash receipts from customers that were not deposited into the bank account.
After a detailed review of the books and records, we interviewed the principal and, as a result, we determined that in addition to the misappropriation of cash, he also wrote himself extra payroll checks that he cashed and subsequently voided from their accounting system. In a report to our client, these were our findings:
• Cash was received from customers and not deposited into company bank
• The principal falsified the books and records to conceal the theft of cash.
• The principal wrote unauthorized checks to himself for additional wages and
• The principal cashed unauthorized checks and subsequently them from the
company’s accounting system.
• The principal admitted to the theft of cash.
This was one example of how a lack of internal controls, specifically, not segregating employee’s duties and responsibilities due to economic conditions, could result in financial ruin for a small business.
During good economic times, employee theft costs companies billions of dollars annually. Now, in the worst economic period since “The Great Depression”, opportunity and perceived financial need are at all time high. This is recipe for financial ruin for the small business owner. With mounting pressure to cut costs and streamline overhead, the small business owner must make tough decisions. Even if financial limitations prevent the proper segregation of duties and responsibilities, there are some positive steps companies can take to eliminate the opportunity for employees to commit fraud.
• Require annual vacations. This is a crucial internal control for all companies.
Numerous frauds have been uncovered while employees are on vacation.
• Create a Code of Conduct. Require employees to sign a code of conduct.
Communicate to the employees the penalty for wrongdoing.
• Prosecute if crimes are committed. If the employee is sure that crimes will be
prosecuted, this make act as a deterrent.
Fraud experts agree that fraud depends on motivation as much as opportunity. So what motivates a fraudster?
• Financial Pressures. Living beyond one’s means, poor credit, or unexpected
• Vices/Addictions. Drugs, gambling, etc.
• Workplace issues. Lack of motivation, recognition, and feeling underpaid.
• Other rationalizations. The company has insurance or I’m not hurting anyone.
If a company is able to segregate duties among various employees, the following list of bookkeeping procedures should help prevent some employee fraud:
Mail is opened by an employee who does not perform bookkeeping functions.
Cash receipts are not handled or recorded by employees having access to accounts
receivable or general ledger.
Cash receipts should be deposited daily.
Sales staff and/or drivers should not handle or accept cash receipts.
Bank accounts should be reconciled independent of cash receipts, accounts
receivable, and general ledger functions.
Employees responsible for posting receivable accounts should have no access to
Cash receipts should be applied to specific invoices rather than current balances.
Delinquent accounts should be followed up independently of cashier.
Even though fraud by collusion between employees with separate responsibilities can occur, studies show that 87% of frauds are perpetrated by employees who act alone. Therefore, small business owners should be more concerned about control breakdowns and supervisory failures than collusion.
In conclusion, small business owners must make the right decisions with the resources available to them and be prudent watchdogs over their assets. They must try to implement the basic internal control procedures.
About The Author:
Robert D. Jones CFE, CBM has been involved exclusively in the field of Forensic Accounting and Corporate Investigations for over 25 years. He has worked extensively with insurance companies, public corporations and private companies, attorneys, and private individuals focusing his career on Financial Forensics and Investigations. He has testified on numerous occasions as an expert in Civil and criminal matters. He is a proud U.S. Navy Veteran. Mr. Jones is also a California Licensed Private Investigator.