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June 2012 Tip of the Month

Even For A Small Business, Proper Internal Controls Are Critical

In a start-up business internal control is seldom necessary since the owner is generally able to directly supervise all of the firm’s activities, and to personally control cash inflows and outflows.  But as an organization grows, and authority and responsibility have to be delegated, a sound internal control system becomes vital for management to obtain accurate financial and operational information, to safeguard the firm’s assets from theft and waste, and plan and monitor future growth.  Elements that should be present in a soundly functioning system include:

  • Organizational controls that establish productivity standards, hiring standards, work hours, procedures, etc., for all functions within the organization.

  • Budgets for planning and controlling operations.

  • Division of responsibility for record keeping, asset custody and transaction authorization.

  • Physical controls that restrict access to assets by unauthorized personnel.

  • Documentation controls to insure accurate and complete accounting for all transactions.

  • Internal and independent auditing to monitor compliance with the established internal control structure.          
White collar crime is estimated to cost U.S. corporations billions of dollars a year.  It is generally acknowledged that this type of crime has reached epidemic proportions, severely hurting both large and smaller firms.  Yet, much of this crime wave is preventable by establishment of sound internal control procedures. 

According to the FBI, the numbers and percentage of inside criminals that are prosecuted versus outside criminals has completely reversed, with a far greater number of insiders being caught, charged and prosecuted.  Following are some practical suggestions for the establishment of internal controls that should deter white collar crime in your organization:
  1. Require different individuals to authorize or approve checks, vouchers, credits or any other activity that generates payment of cash.  (The more people involved in the authorization process, the more difficult it is to generate a phony cash payment.)
  1. Segregate the payment distribution function from the receiving function for goods and services
  1. Establish approved vendor lists and establish ID numbers for each vendor in your accounts payable system.
  1. Require buyers, purchasing agents and others in sensitive positions to render monthly reports indicating whether they have received gifts, gratuities or other forms of consideration from vendors.
  1. Utilize stringent employment practices that involve screening and checking of employee backgrounds.
  1. Require prospective employees to sign liability waivers so that complete reference checks can be undertaken with former employers.
  1. Utilize fidelity bond insurance to cover anyone handling cash or negotiable instruments.
  1. Introduce intentional errors into the system to see if they will be detected and reported.   (Examples include missing supporting documents, absence of approvals for transactions, etc.)
  1. Utilize internal auditors or require your outside accountants to spend additional time reviewing details of transactions.
  1. Establish firm policies that reflect fairness and equitable treatment toward employees (incentive pay, profit sharing, employment stability, to name a few.)
While there is no foolproof way to insulate an organization from white collar crime, Abo and Company suggests companies reduce their risk by establishment of sound internal control systems.