Internal Controls for Small Business

Small businesses have a staggeringly higher risk of fraud than large companies due to lack of internal controls. Though business owners have developed a heightened awareness, the impact on businesses continues to grow at alarming rates.

The most common forms of occupational fraud are asset misappropriation (billing schemes and check tampering schemes, payroll, and expense reimbursements), financial statement fraud and corruption (more likely to occur at large organizations).

How is Fraud Carried Out?

Knowing the most common ways that fraud is carried out and concealed can help you understand what to monitor closely and why. For example, occupational fraud is often concealed through:

- Creating fraudulent documents

- Altering documents

- Altering transactions in the accounting system

- Creating fraudulent transactions in the accounting system

- Destroying or altering electronic documents

- Altering journal entries

How is Fraud Detected?

Most often from:

- A tip (employees, vendors and customers)

- Fraud hotlines

- Internal audit

- Management review

Strong internal controls are a critical preventing fraud. As a business owner, there are several basic exercises you should perform on a regular basis:

Fraud Prevention/Protection

- Check references and run background checks on all prospective employees and vendors. Ask previous employers if the prospective employee is eligible for rehire.

- Develop a written code of conduct that explicitly prohibits fraud, conflicts of interest, kickbacks and other illegal acts. Practice and strictly enforce the code.

- Owners who dip into petty cash, fudge on an expense report or set other examples of loose business behavior will find employees rationalizing dishonest actions. Set an ethical example for employees to follow and treat them with respect and fairness.

- Carry appropriate insurance policies to limit your company’s exposure to fraud losses.

- Ensure that no employees or vendors are added to the payroll or approved vendor listing without your approval. Periodically review the payroll and approved vendor list to ensure none have been added without your knowledge.

- When employees leave, be sure to disable access codes and passwords immediately on such things as software, network, email, laptops, hard drives, office, banking information if they had access and even online subscriptions.

- Personally approve large credit memos, price concessions and bad debt write-offs.

- Have customers mail payments directly to a lock-box maintained by your bank.

- Require that your receptionist or someone independent of the accounting department open the mail and log cash receipts received at your office location. 

- Periodically reconcile daily cash receipts logged by the receptionist (or other) to individual customers account details, as well as the amount deposited per the bank statement.

- Examine all original invoices and receiving documents (not copies) when signing checks to ensure that the prices are reasonable, that goods were actually received and that the vendor is legitimate.

- Never use a signature stamp for check signing. Notify your bank that only original signatures are valid.

- Require that the bank obtain your authorization for all electronic fund transfers.

- Notify your bank that the employee who makes the daily bank deposit is not authorized to receive “cash back” from your deposit.

- Have supervisors review employee time daily to ensure time worked was reported accurately.

Fraud Detection

-Monthly bank statements should be delivered unopened to the owner, who should review them in detail for irregularities such as unexpected declines in balance, overdrafts and unusually large disbursements.

- Cash disbursements and receipts should be reviewed in detail by an independent accountant at least annually to ensure all recorded transactions are supported by valid source documentation and are consistent with business reality.

- All bank accounts should be reconciled monthly. These reconciliations should be reviewed periodically by an independent accountant to ensure the propriety of the reconciliation.

- Have an open door policy. Approximately, 26% of employee fraud is discovered and reported by a fellow employee. Ask your employees to identify ways in which someone could commit fraud at your company and the ways to avoid it.

- Review monthly financial statements in comparison to a budget and prior period actual and investigate unusual fluctuations. Also compare financial ratios to benchmarks.

- Take note of employees who appear to live substantially beyond their means.

- Send monthly statements of customer account balances. The statement should indicate the name and number of a contact person, who is independent of the accounting department, to call with complaints/discrepancies.

- Have an independent accountant review the payroll function at least annually to ensure that pay rates are consistent with the employee’s personnel file and that hours paid agree to manual time cards or time sheets.

- Require that key accounting personnel take a vacation at least annually and that someone perform their job function in the interim to detect possible irregularities.

- Perform full inventory and fixed asset counts at least annually and investigate significant shrinkage.