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Internal Controls for the Small Business - Part 1

An unpleasant fact of business is that some customers shoplift, some vendors and suppliers overcharge and short-count on deliveries, some employees embezzle or steal assets, and some managers commit fraud against the business or take personal advantage of their position of authority in the business.

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Small and medium-sized businesses are a natural target for indiscretions. Even a relatively small business handles money, holds assets, and deals with people - a perfect mix for bad things to happen. To protect against these threats, a small business should put into place and vigorously enforce internal controls. Various precautions are established to minimize losses from all types of dishonesty and honest mistakes against the business from within and without. Big business generally understands the critical importance of internal controls.

Many small business owners feel either they are too small for internal controls or they can’t afford to put them in place. Even a relatively small business can enforce certain internal controls that are very effective. Among these are the following:

  • The owner/manager should sign all checks, including payroll checks. This practice allows the owner to keep an eye on the expenditures of the business. An accountant, a bookkeeper, or the controller of the business should not be given check-signing authority. This person can conceal fraud if she has check-writing authority.

  • Require that employees take time off. Make sure that another employee carries out their duties while they are gone. By doing so, the fill-in worker serves as a check on whether things are being done correctly.

  • Consider the job-sharing approach. In job sharing, two or more employees are regularly assigned to one area of the business on an alternating schedule. Each employee acts as a check on the other so that both use established methods and procedures. When a second employee shares the job, embezzlement is more difficult to conceal without collusion.

  • Pay attention to the lifestyles of your employees without violating their privacy. If an employee appears to be living more lavishly than their income would suggest he should, perhaps some improprieties are occurring.

Strong and tight internal controls are needed in high-risk areas. Owners should identify which areas of the business are the most vulnerable to embezzlement. The most likely fraud points in a business generally include the following areas:

  • Cash receipts and disbursements

  • Payroll (including workers' compensation insurance fraud)

  • Customer credit and collections, and writing off bad debts

  • Purchasing and storage of inventory

Cash is the highest risk area for most businesses. The small business should make sure that all checks mailed to the business and cash collected at the point of sale are recorded in its cash account. For this reason, many small business owners open their mail each day and count the money in their cash registers at the end of each day. They make deposits in their bank accounts themselves. You may or not have time to take this action. If you don’t, it’s best to have someone who does not have access to the register handle this responsibility.

The person opening the mail that includes cash collections from customers and the person counting money in cash registers should not be the person who records the entries in your cash account. Assign someone other than the bookkeeper the responsibility for opening the mail and counting cash in the registers.

The bookkeeper is generally given the responsibility for preparing the required forms and paperwork that are presented to managers for payment approval. But the bookkeeper should not be given the authority to sign checks. The bookkeeper should not mail checks.

Next quarter we will explore other practical internal controls that will assist small businesses. Mitchell & Associates has an internal control program for small businesses where we put in, implement and monitor controls. If you are interested, please let us know. It is a very important component of a successful business.

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