How To Protect Your Cash and Inventory Balances From Theft
I think we can all agree that rushing can lead to mistakes. Depending on the task, the mistake can be small or significant. I went to a parenting class years ago that touched on this topic. Parents need to teach kids how to behave “before their mistakes become more expensive”. I’ve always remembered that statement.
Mistakes made in business can be very expensive. In fact, some mistakes can literally put you out of business. One good example is employee theft. If a business does not have proper controls in place, a dishonest employee can steal thousands of dollars (or even hundreds of thousands) before they are caught.
This is a discussion of how you can set up controls to prevent theft of cash and inventory.
The risk of growth
Growing your business is exciting. Adding new customers validates your business plan. Your product or service must be helping customers solve a problem, which is satisfying.
Growth, however, makes everything more complicated. You have more accounting transactions, more sales and more products to ship. A growing business may also hire more employees.
Obviously, you can manage growth by hiring more people or outsourcing tasks to a third party vendor. Before you hand off work to a staff member, however, you need to have some critical controls in place. If not, your business will have a high risk of employee theft.
Segregation of duties
One way to reduce your risk of theft is to segregate duties between different employees. Now, this should make logical sense: the less responsibility any one worker has, the less likely it is that theft can occur. Let’s think about your company’s cash account as an example. Whenever possible, these 3 specific duties should be kept separate:
- Custody of assets: The person who has physical custody of the checkbook should not have any other duties related to cash processing. Another good example of custody is the keys to a company warehouse where inventory is stored. Let’s assume that the administrative assistant has the checkbook in his desk.
- Authority: Who has authority to sign a check? If you own a restaurant, for example, your manager may have authority to sign checks for purchases of food received at the restaurant. That same manager should not have access to the company checkbook.
- Recordkeeping: This duty refers to posting accounting entries and reconciling the bank account. Over the years, I’ve helped many small businesses with their accounting needs. I always explained that I couldn’t be allowed to sign checks for the business. The role of the accountant must be segregated from the other duties.
For a very small business, it may not be possible to segregate these duties. Maybe the owner handles two or even all three of these tasks. A growing business, however, needs to separate these duties.
In addition to segregating duties, there are two other steps you can take to help prevent theft:
Procedures manual
It’s important to have written procedures for every possible task you perform in the business. This is particularly important for routine tasks that are performed every week or month.
For example, assume that your firm has a specific procedure for generating invoices. The accounting department gets information from the sales department and the shipping area. Your accounting department uses that documentation to generate an invoice. You need to document what records are required to generate the invoice and who performs each task.
Maintaining an updated procedures manual helps clarify your business operations. The manual eliminates any confusion about who performs a certain task. A procedures manual is a great training tool for new employees.
The biggest benefit, however, may be related to preventing fraud. If everyone follows the steps in the manual, you’ll know exactly how a task is performed and who does the work. If someone tries to commit fraud, however, they’ll have to deviate from your written procedures. That change from normal procedures may be caught faster.
Bank reconciliation
Some employee theft is difficult to detect. If two employees work together to commit fraud, it’s referred to as collusion. Your written procedures may not catch two of more people who decide to collude. However, there are other steps you can take to identify the fraud soon after it happens.
One way to detect fraud is to reconcile your bank account in a timely manner. Ideally, you should reconcile within 4-5 days of getting your bank statement. Since statements are now available online, you may be able to download your statement on the first day of the next month.
A great deal of fraud can occur through the cash account. Your cash account may have lots of transactions involving different people in your company.
The accountant performing the reconciliation should look carefully at the vendors who were paid. Did each vendor provide a legitimate product or service? Is their evidence of that product or service? Your company should insist that supporting documentation is attached to each check request.
You should maintain an updated procedures manual and reconcile your bank account quickly after month-end. If you do, your company may be able to uncover a small fraud before it becomes a big, expensive fraud.
Now that we’ve discussed some important controls, let’s talk about a common business fraud situation.
Fictitious payee
A fictitious payee occurs when a business pays a vendor that isn’t legitimate. This “fake vendor” has a company name, address and bank account controlled by an employee who is committing fraud.
I worked with a tree service company is suburban St. Louis years ago. They took calls from customers and sent out crews to cut down trees, pull out stumps, etc.
There was a big storm in a small town south of St. Louis. The owner, Joe, sent a foreman and a crew to the small town to perform tree service work. There was a lot of damage in the town, so the crew kept busy for 3 weeks or so.
Shortly after the work ended in the small town, the foreman quit. Joe, the owner, noticed that no customer payments were coming in. The foreman was given a printed pad of invoices to fill out and hand to customers. He talked to the crew, and then took a crew member back to the town to visit some customer job sites.
Joe knocked on some doors and was told that yes, the invoice had been paid. He asked a customer to show him the invoice. As it turned out, the name on the invoice was slightly different than his company name. The address was also different.
The foreman had created a company name and address that he controlled. Once he handed out all of the fictitious invoices, he quit the company.
Preventing the fictitious payee fraud
In this instance, the foreman didn’t control the checkbook, but he did control the invoicing process. He was able to create his own invoices without being detected. Another business control is to number all invoices and ensure that invoices are sent to customers from your accounting department.
Inventory risks
Other than cash, two of a company’s biggest assets may be accounts receivable and inventory. To protect those assets from theft, you need to apply the same segregation of duties guidelines.
The bank reconciliation is the best way to confirm your cash balance. In a similar way, an inventory count confirms that your accounting records agree to the physical inventory items you have on hand.
Here are some tips related to an inventory count:
- Frequency of your counts: Counting inventory can be a huge investment of time and money. However, confirming such a large balance is important. You should perform a physical inventory count at least monthly. If any inventory has been stolen, you’ll catch the theft during the count.
- Performing your count: The accounting department prints a list of each item in inventory. The list includes a description of the items, the number of items and the cost. Each inventory item is given a tag. During the count, your staff (and possibly your outside CPA firm’s staff) agrees the detail from the inventory reports to the information on each tag.
- Security: On the day of your count, no inventory should be moved in or out of your warehouse. If you’re counting inventory on September 30th, for example, you seal off access to the warehouse on the night of the 29th. Once your warehouse is closed and inventory activity stops, you generate your accounting reports.
Based on your count, you may increase or decrease your inventory account balance. The goal is for your accounting records to match the physical inventory on hand.
Reduce risk while you manage growth
Growing your business can be exciting, but you’ll also face some risks along the way. Take the time to set up procedures to prevent employee theft. You can grow your business and have some peace of mind.
Note from Aaron Moss:
I’ve personally seen a few cases of fraud within a business, it can be absolutely devastating. In addition to destroying trust, it typically results in an instantaneous termination, so now you have a position to fill, you’ll probably not get the money back, and it makes for a huge headache. And if you think you can “spot” the kind of person who will do this, think again. I’ve seen ‘gangster looking thugs’ that are as honest as the day is long and ‘little church ladies’ that will rob you blind.
Trust, but verify…Twice.
