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How Internal Controls Should be Utilized by Small Businesses

Surprising Reasons that Your Business May Experience Fraud without Internal Controls

Although the importance of internal controls is often overlooked by many small businesses, the fact remains that they are actually a vital component to profitability and success. Small businesses are often quite vulnerable to problems such as theft, employee embezzlement, scams, fraudulent schemes and other kinds of employee or customer crimes. Internal controls are generally needed in other to provide protection against these problems. Small businesses should follow the lead of larger companies, who traditionally place a great deal of importance on internal controls. If a business, whether it be large or small, doesn’t pay attention to internal controls, it’s almost as though they are leaving themselves open to theft and corruption. If your small business hasn’t yet implemented internal controls, here is a list of some of the basic ones that should be followed.

Statistics on Fraud for the Small Business

Even the smallest of businesses can benefit from effective internal controls, and a big reason for the need for internal controls is fraud.  According to the Association of Certified Fraud Examiners (ACFE), more than 39% of fraud occurs in businesses that have fewer than 99 employees, and payroll fraud schemes are the biggest loss to business.  In fact, the ACFE reports that payroll fraud schemes in small business cost the small business industry around $600 billion dollars last year.  The average business loss per incident was more than $125K dollars.  Small businesses are often vulnerable to fraud due to their lack of accounting controls.  The actual controls put in place may vary according to the needs of the business, but they generally should include such precautions as requiring the owner or manager to sign all of the company’s checks. This simple practice can be helpful to make sure the owner or manager is keeping close tabs on a business’ expenditures. If these duties were to be handed over to a bookkeeper, an accountant, or even the Controller, it could leave the company more vulnerable to fraud. Job sharing is another simple practice that small businesses can use to help provide checks and balances. Because no one person is solely responsible for any one duty, any kind of attempted embezzlement or fraud would be harder to conceal.

Keep Close Tabs on High Risk Areas

There are always going to be certain areas of any business which are at greater risk for theft and fraud. These areas often include payroll, purchasing, customer collections and credit, and cash receipts and cash disbursements. Of these, cash disbursements and cash collections are risky, but payroll may represent the biggest risk. For many small businesses, the best practice is to have the owner or manager open the mail, count the cash register money, and make the bank deposits. If this is not possible, then these duties should be assigned to somebody who doesn’t have responsibility for keeping track of the money. Split up these duties so that there are always checks and balances in place.

Utilize the Element of Surprise

Surprise inspections and audits are a good way to avoid potential problems. For example, an unexpected inventory could reveal product theft. These surprise tactics are also a good way of discovering “inventory errors” which were actually attempts at fraud.

Insist on Audit Trails

It’s very important for a business to create audit trails for all transactions. You should be able to go back and see records and documentation for every business transaction, along with its supporting and source documents. These records should be kept well-organized and should be retained for a set period of time.

Balancing Internal Controls with Privacy Rights

Of course, a business should never have internal controls in place that violate employee or customer privacy rights. This kind of practice can leave a small company vulnerable to lawsuits or other kinds of legal actions. Making unfounded accusations is a sure way to cause problems for your business.