Notebook/27/dp1st/mark2nd
Wendy Klein
Don’t make the mistake of thinking that business success protects you against embezzlement. In fact, success can make you more vulnerable to this type of fraud.
Here is a typical scenario: you’ve turned years of dreaming into reality and have your own business. You are good at what you do, and your business has grown. You’ve hired people to handle key administrative tasks, and you have less time to oversee your employees.
When you ask, they tell you everything is fine. You trust these people. That’s why you hired them. You have no reason not to believe them. They’re practically family.
So it is with many small but quickly growing firms until the day the owner discovers a trusted employee has robbed him or her blind.
Take the case of a local veterinarian who was horrified to find out a trusted employee had embezzled at least $1 million from the practice. The theft decimated the pension plan, as well as an effort to care for homeless animals.
How could this happen to an intelligent business owner, one smart enough to get through veterinary school and build a successful practice?
The employee handled all the difficult day-to-day problems in order to allow the vet to focus on healing sick animals. The worker dealt with vendors, opened the mail and gave the boss only what needed direct attention. The employee was the liaison with all outside professionals and organizations, including banks.
The vet loved this because it allowed time to concentrate on patients. So did the employee, who worked tirelessly and seldom took vacations. Before too long, the worker knew more about the financial side of the business than the vet did. Outside parties became accustomed to the apparent authority. Those who should have been dealing with the boss as the business owner naturally started to accept and deal with the employee. As a result, the vet lost touch with the business side of the firm a mistake that was later paid for dearly.
Unfortunately, the story is not unique. Small-business owners everywhere are faced with similar predicaments.
When you run a small business, it isn’t always possible to safeguard your assets with internal controls. Often, employees must wear several hats simply to get the day’s business done.
Consequently, books and records become disorganized. At best, a hasty job is done to put a financial statement together in order to prepare the annual income tax returns. This situation is typical, and creates a tempting environment for an unscrupulous or desperate employee to make off with your hard-earned money.
Financial audits aren’t designed to detect all types of employee fraud, despite the popular belief that they will. Some of the methods used by thieves are so devious that the most highly trained professionals can easily miss them. However, the following “red flags” should be immediately investigated:
? An employee who holds incompatible duties (for instance, check signing and bank reconciliation).
? An employee who works irregular hours or is reluctant to take vacations.
? Expense accounts that are unexplainably inconsistent with prior-year figures.
? Balance sheet accounts that are accumulating without explanation.
? Payments made to vendors you are unfamiliar with.
? Major lifestyle changes by employees. (The most frequent explanation given is recent inheritance, but don’t immediately buy into this.)
You can take action to prevent embezzlement. Here are several important ways to safeguard your business from this type of crime.
? Segregate duties. The person who writes your checks shouldn’t be the person who reconciles the bank accounts. If there’s no intervening person, the embezzler can’t be caught.
Separating incompatible duties makes it difficult to adjust entries to the cash account to cover embezzlements, and for employees to write checks to themselves.
A good overriding control is to have the monthly bank statement delivered directly to the business owner, who does a careful review before passing it along for reconciliation.
? Limit financial information. Because of the possibility of misuse, employees should not have access to financial information, credit card data, lists of business contacts or material not directly related to or necessary for their job.
? Make vacation time mandatory. In addition to giving your employees some necessary relief from what may be a stressful job, encouraging them to take vacations gives you the chance to look at what they are doing.
When someone else takes over a key employee’s duties temporarily, many of the commonly used methods of fraud become harder to cover up. To perpetrate certain types of fraud, it’s necessary to be in the office almost all the time.
? Conduct a surprise audit. Unexpected reviews of financial information can uncover abuses, or identify areas where controls and procedures should be improved.
An outside accountant, internal auditor or the owner may conduct an audit if they really know what they’re doing. Even simply going through the process will make employees re-think what they might be doing.
An example of this might be for the business owner to sometimes personally distribute the payroll checks, to be certain that no “phantom employees” have been created.
? Get timely financial information about your business. Understand your financial statements and make sure the data is in line with how you believe your business is doing.
If you are unsure or need professional guidance, consult with an accountant. Even if you don’t enjoy the financial end of running a business, as a business owner you must stay involved for your own protection.
When it comes to your financial health, an ounce of prevention is worth a pound of cure.
Wendy Klein is a certified public accountant who manages the South Bay office of Roth Bookstein & Zaslow.
Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.
