Financial Controls to Protect Your Money from Fraud and Theft

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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One-third of all business failures can be traced to employee theft, according to AllBusiness.com. Outright stealing of products off store shelves or distribution racks may be obvious cases of such theft. Diverting proceeds from cash sales, borrowing money from company funds without express permission, double-charging customers and pocketing half of the receipts, and waiving fees for a friend are less noticeable ones.

If you're busy setting strategic direction, meeting with clients, and negotiating with vendors, you'll need to delegate scrutiny of every business transaction — but don't forsake business continuity. Carve out time to establish financial controls, monitor bank balances, conduct audits, and investigate unusual activities.

Review bank statements on a monthly basis.

Look at balances and transactions for each bank account, including those dedicated to day-to-day operations, payroll, and funds held in escrow. Ask for back-up documentation to audit vendor payments.

Analyze payroll including overtime, bonuses, and commissions. Make sure that deductions for health benefits, 401(k) plans, and payroll taxes are placed in appropriate holding accounts and disbursed according to schedules. Pay attention because you won't discover the repercussions of bogus commissions, unreleased dollars to benefit providers, and unremitted taxes to the IRS until there's a significant problem.

Examine escrow accounts regularly, even if there is generally no activity. Don't wait until funds are requested to verify balances, as mishandling can go unnoticed for several months otherwise.

Audit ACH transactions.

The ease of scrutinizing ACH transactions hasn't kept pace with their ever-increasing volume, Tom Marcoux, principal of Reserve Capital Value LLC (a treasury and technology consulting firm) tells me. He warns that banks often have inconsistent processes and systems for handling these transactions, particularly international ones. As a result, ACH is a potential source of fraud.

Set up financial controls on ACH transactions, similar to the ones for traditional forms of customer invoicing, receipts and posting of payments, and deposits to company bank accounts as well as vendor invoice approvals and payments. Assign oversight for these tasks to different employees, even if the streamlined electronic tools mean that just one employee could reasonably handle these accounting functions.

Examine vendor relationships.

Periodically, conduct a review of vendor relationships to verify their existence and confirm that pricing is consistent with product value, service levels, and market conditions. Employees who embezzle might issue and subsequently cash checks to fictitious vendors. They may concoct schemes to overpay vendors and pocket the difference to boost their personal bank accounts.

Count and reconcile inventory.

Keep running totals of materials and finished goods that are received, used in production, transferred, and sold. Compare physical inventory counts with administrative records, and then research and deal with any discrepancies.

Take annual inventory counts or perform cycle counts of certain items throughout the year, rotating through the entire stock annually. Periodic counts during the year can uncover problems, allow you to institute tighter procedures, and help avoid surprises at year-end. Just as significantly, watching inventory means that you can deter and detect employee theft.

Arrange for independent reviews of financial statements and tax returns.

Tom recommends this basic but critical action. Though you're most knowledgeable about your business, an outside entity can easily spot red flags that you're likely to miss.

Keep personal funds and business funds separate.

Tom describes "intermingling funds with different entities and personal accounts without any controls for accurate reporting" as a form of self-embezzlement. He adds that "sometimes an unlucky 'partner' or deal associate may lose out in the confusion."

Maintain separate bank accounts for various legal entities, or set strict guidelines for capturing movement of funds and end-of-period reporting. You'll find that this separation can give you a clear picture of the health of your business and the amount of cash that it generates.

Establish, communicate, and monitor compliance with policies relating to sensitive information.

Define sensitive information, which should include credit card, bank account, and social security numbers of your customers, vendors, and employees. Set levels of security access and control access.

Design methods for keeping information secure when a transaction is being processed and destroyed after a transaction is complete. Specify how electronic and hand-written information will be stored and protected.

Control charge card use.

Be clear about appropriate uses of charge cards. Set policies for business and personal use along with timelines for authorization and reimbursement of expenses.

Tom shared easy-to-follow, customized controls set by a former employer. His company provided him with an American Express card for the specific purpose of paying for meals during a training event in New York City. He followed a pre-set budget and any charges over budget (or for non-food/beverage items) were billed to him personally. The solution helped him and human resources administration as there were no expense reports to file and process or wait times for reimbursement.

In addition to customized controls, Tom suggests appropriate credit and background screening of employees who may receive business charge cards.

Pay attention to customers' and vendors' inquiries about money missteps, particularly recurring ones.

Investigate overcharges, double billings, discounts authorized but not reflected in invoices, extra fees, etc., especially if the complaints seem to occur after you've taken steps to address system problems or straighten out procedures. Sometimes, customers and vendors can see fraudulent activities much more clearly than you can.