A starting entrepreneur normally operates the business by himself, with perhaps some relatives helping out. But as the company grows, he slowly realizes the need to hire outsiders.
When this happens, he has to divide responsibilities between himself and his employees, delegating tasks accordingly. At this point, he needs to establish an internal control system to avoid error, fraud, and oversight.
Such a system guards against losses resulting from employee lapses and abuses. The system is also meant to prevent fraud, control financial losses, and minimize errors and omissions.
Two actions are needed to put in place an effective internal control system: safeguard physical records to reduce unauthorized access, and segregate duties to avoid conflicts of interest among the staff. The latter may involve limiting an employee’s access to an area of business – cash transactions in particular.
Even when you have only one or two employees, this system of checks and balances can help you maintain control over your cash flow. While a P1-million loss is unlikely in a small business, a P10,000 loss may be too much.
Three conditions make fraud possible in any business: First is the need for money, a common condition that tempts even the most honest of employees. They may become vulnerable and desperate when a usurer comes knocking on their door, when it’s already enrollment time, or a seriously ill parent racks up an astronomical hospital bill. Sometimes though, their backs are pushed to the wall because of an extravagant lifestyle, a drug addiction, or a gambling habit.
Second is an environment that gives employees the opportunity to commit fraud. An employee could simply circumvent the system and take advantage of loopholes in the process. Leaving the petty cash box unattended is a simple but ordinary occurrence. Or an employee may just avoid counting the inventory so losses cannot be determined.
Third is lack of integrity. Crooks justify their fraudulent acts with “I am just borrowing the money from the company and will pay it back later,” or “Everybody is doing it and nobody will get hurt anyway,” or “I need the money more than my boss does.”
Everyone in the company can commit fraud – from the rank-and-file employee to the manager. To spot a potential fraud, a business owner would do well to observe changes in his employees’ habits and lifestyle. He should also be on the lookout for changes in employee behavior – if they are becoming defensive or argumentative, blaming others for their mistakes, not being able to look people in the eye, sweating excessively, shying away from office mates or coming to work late.
Depending on the magnitude of fraud committed, an employee who is caught stealing money or inventory from his employer can be dismissed from work or taken to court, or both.
But more than internal controls, remember that in the long run, the best prevention against fraud is to care for your people. Foster loyalty and genuine concern among your employees by providing regular counseling on family problems, health education, and financial planning.
The Red Flags
- Fraud is probably being committed in your company if you notice the following:
- Missing documents
- Common names or addresses for refunds
- Inventory shortages
- Alterations on documents
- Cash shortages
- Increased due receivables
- Duplicate payments
- Unusual endorsements on checks
- Unexplained adjustments to inventory balances
- Unusual patterns in deposits in transit
- Old outstanding checks or dormant accounts suddenly becoming active
- Customer complaints
Being in Control
Here’s how to minimize fraud in your business:
- Be clear and precise about each employee’s functions. Establish straightforward job descriptions and performance evaluations.
- Spread the tasks. Assign different tasks to different people. For instance, a person handling the accounts payable must be different from the one receiving the ordered goods. Yet another should oversee dealings with vendors and another to take care of accounts receivables.
- Maintain the system. Keep internal controls in place. Personally approve new vendors and make sure that all ordered items are received in the right model, quantity, and quality.
- Be hands-on. Personally sign each check and review the invoice, receipt ticket, and purchase order. If you have a job order cost program, see that appropriate purchases are made.
- Do the audit yourself. Counter-check travel and entertainment expenses, then match them with the scope and nature of the business trip.