Internal Controls Essential to Combat Employee Fraud
Inflation and Financial Stress Heighten Risk
Internal controls are processes designed to prevent or detect errors and mistakes, including those caused by fraud, waste and abuse.
Strong internal financial controls are always essential, especially during times of high inflation and a looming recession, as the nation is experiencing now. Though no one wants to think about employee financial fraud occurring in their business, such activity increases during inflationary times when employees may feel personal financial pressure. Therefore, ensuring that adequate internal controls are in place can protect both your business and your employees.
The ‘Fraud Triangle’
Three factors come into play when employees steal from their employers: motive, rationalization and opportunity – known as the “fraud triangle,” according to the biennial survey Occupational Fraud 2022: A Report to the Nations by the Association of Certified Fraud Examiners.
Financial pressure brought on by the rapid rise in costs of gas, groceries and other goods in recent months can provide a motive, inducing an otherwise honest employee to think about taking money from the till. The employee may rationalize the idea by planning to pay the company back as soon as possible. However, when the opportunity presents itself – such as paying a personal credit card bill with a company check, then entering the expense under a vendor’s name in the general ledger – the deed is done.
Strong internal financial controls can help allay each element of what is known as the “fraud triangle,” but they are particularly effective at addressing the third leg of the triangle – the opportunity for fraud. Keeping internal controls strong can be especially difficult when your accounting department is short-handed and finding qualified finance personnel is as tough as it is now. The most common weaknesses in internal controls at small and medium-sized businesses are:
- Lack of segregation of duties. Your accounting personnel may fill multiple roles if the department is short-handed, which can create weaknesses. For instance, the person who can write checks with signature authority or access bank accounts should not be doing the bank reconciliations or entering expenses into the general ledger.
- Management has insufficient oversight. Some inconsistencies in the books can be caught with a careful monthly review of the check register or account details when reviewing the financials. Few business executives perform this kind of detailed review regularly.
- Inappropriate check signing authority or practices. The person who signs the checks should not have control over everything else. Some organizations require two signatures on all checks or checks over a certain amount. This can be cumbersome, but it is a good practice. In the case of electronic payments, some bill-paying platforms offer a feature that will hold the check until two people have authorized it online. Even if you do not require two signatures, someone who does not pay the bills should review all bill payments regularly.
- Delayed or outdated financials. Keeping your books current can help you detect variances that can indicate a problem. For example, if you order a large amount of raw materials every year in June, you may know what they should cost when you factor in normal inflation. An unusual jump in year-over-year costs would indicate a variance that should be investigated. But if the books are not current and you are not reviewing expenses closely on a regular basis, this kind of variance could be missed.
Occupational Fraud 2022: A Report to the Nations, ACFE shared data and information gleaned from studying 2,110 fraud cases across 133 countries, resulting in a collective loss of $3.6B. Below are some key data points from the report:
- The average loss per fraud case is $1.7M.
- Organizations lose an average of 5% of revenue to fraud each year.
- 29% of fraud occurred due to a lack of internal controls.
- 20% of fraud occurred by overriding existing controls.
- Nearly half of all fraud came from these four departments:
- Operations: 15%
- Accounting: 12%
- Executive/Upper Management: 11%
- Sales: 11%
How Outsourced Services Can Help
- During inflationary times, businesses need the most accurate and timely financial reports possible. Making the right business decisions – like adjusting prices to ensure your profit margins are not slipping – relies on accurate real-time data and substantial control over assets.
- An outsourced professional can help streamline your finance department’s operations, implementing strong internal controls and ensuring each internal employee is fulfilling the appropriate functions for their level.
- Most importantly, outsourcing allows you to engage the fractional services of a CFO or controller who can bring analytical and strategic skills to your finance team that support executive-level decision-making. Amid today’s tight labor market, outsourcing finance functions can stabilize an organization, avoiding the need to post job openings and train new hires.
While outsourced accounting services may provide a bulwark against employee fraud during times of economic volatility, in the long run, they also bring consistency, timeliness and reliability to an organization’s financial reporting.
Internal controls should be clearly documented in policy and guidance, routinely re-evaluated, and tested to ensure they are working appropriately and consistently executed by business process owners or end users. Contact an Adams Brown advisor to discuss how you can strengthen internal controls in your organization.