Stop Fraud Before It Starts: Essential Internal Controls for Small Businesses

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Delegate CFO: Hello, everyone.

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Delegate CFO: Welcome to today’s webinar about internal controls.

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Delegate CFO: Now, this particular webinar is near and dear to my heart, because as many of you know, not only am I the owner of Delegate CFO, I also own another company, HublinForensic.com.

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Delegate CFO: And on that side of my companies, that’s where I do my forensic investigations. I investigate fraud, embezzlement, so on and so forth.

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Delegate CFO: And unfortunately, in that particular company, I’ve seen a lot of small businesses lose quite a bit of money, and mainly it was because of

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Delegate CFO: either lack of internal controls or not understanding internal controls. So…

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Delegate CFO: The best forecast budget you could possibly have

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Delegate CFO: won’t amount to anything if somebody’s stealing from you. So that’s why I felt it was important to go ahead and do this particular webinar, to go over what intercontrols are, what’s the importance of them, how much… what’s the cost of not doing them, and then what you can do as a small business owner to have those in place. And again.

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Delegate CFO: Turn controls are crucial for your small business, because all the work you do could instantly evaporate from somebody just stealing from you. So, let’s go ahead and jump into the respective

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Delegate CFO: Webinar. So again, we’re going to talk about stopping fraud before it starts, and the essentials of these particular internal controls.

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Delegate CFO: Again, my name’s Steve Holland, I’m a CPA, as well as a certified forensic accountant.

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Delegate CFO: I’ve been a CPA since November of 2000, and I’ve been doing fraud investigations for almost 15 years now, and I’ve testified both in civil cases and criminal cases.

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Delegate CFO: And so, today, we’re going to cover

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Delegate CFO: What are internal controls, why do they matter, and what’s the impact that, say, poor internal controls can have on your particular company?

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Delegate CFO: First off.

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Delegate CFO: I wanted to kind of give you some statistics from the Association of Certified Fraud Examiners. So, why do internal controls matter? Well.

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Delegate CFO: If you want to know what the effect of fraud… what the effect of fraud has on companies, Google Report to the Nations. Now, that’s a report that’s done every other year, so every two years. The ACFE puts out this report. It’s a very detailed report, you know, it’s got very nice graphics.

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Delegate CFO: And it goes through every single fraud that you could possibly have, whether it’s misappropriation of assets, which is more or less

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Delegate CFO: theft of cash, to inventory theft, to financial statement fraud. It breaks all that down. And then it breaks it down by respective regions, companies.

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Delegate CFO: male, female, so it breaks all that information down. It’s very, very helpful, and it’s very insightful when you go through and review that. But some of the statistics that are really applicable to our presentation today are here on the screen.

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Delegate CFO: From their report, 51% of fraud in small businesses is due to lack of internal controls or override of controls.

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Delegate CFO: And a lot of times, the override of controls, you can just think of as lack of controls, because if somebody’s ever able to override the controls, they’re really not in place to begin with.

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Delegate CFO: So think about that. Over half of fraud happens because there’s no controls in place.

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Delegate CFO: Small boot businesses

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Delegate CFO: lose, on average, 5% of annual revenue. Now, that is a huge number, and I’ll explain why. We’ll walk through that particular 5% here in a second.

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Delegate CFO: But that’s, on average, 5% of annual revenue to fraud.

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Delegate CFO: Median loss, 120. Typical fraud lasts about 12 months before detection. Again, depending on that particular statistics, it depends on how long the employee’s been with the company. Long-term employees, their fraud tends to go a lot longer before they’re detected, but on average, it’s about 12 months before detection.

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Delegate CFO: And turbo controls are not just for big companies. They are for small businesses, as well. So…

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Delegate CFO: Let’s go take a closer look at that 5% of annual revenue.

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Delegate CFO: So right here on your screen, …

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Delegate CFO: I took this from just a news article in Google, so if you have time, I suggest you go into Google, you type in bookkeeper fraud, hit enter.

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Delegate CFO: And there’ll be a whole bunch of stories, and there’ll be quite a few stories.

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Delegate CFO: Month later, two months later, do the same thing. There’s going to be a whole bunch of news stories. So, this fraud happens, it happens quite a bit. So, I just went in, typed in bookkeeper fraud, found this particular article, and this is actually a snippet from that article, and I’ll read it verbatim for you, because it’ll have importance to what we’re going to discuss.

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Delegate CFO: Said Janelle Klein, prosecutor for the Conference of District Attorneys, which represented the state in the case. Some of the owners were using their own money to keep the business afloat and folks employed, believing the company wasn’t profitable, when all the while the problem was Ramos embezzling the funds.

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Delegate CFO: Now, keep that in mind. We’ll come back to that screen, but let’s keep that in mind, so…

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Delegate CFO: Again, on average, 5% of annual revenue is…

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Delegate CFO: taken due to fraud. So let’s do a real quick mathematical calculation so you kind of get an idea as to what this is.

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Delegate CFO: So, on your screen, I just have a very generic company. Said they have a million dollars in revenue, $600,000 in cost of goods sold, $350,000 in operating expense, net income, $50,000.

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Delegate CFO: You’ll notice that net income, the $50,000, represents 5% of revenue. So, in other words, that 5% of revenue is $50,000,

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Delegate CFO: But it also happens to equal the net income.

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Delegate CFO: So, most companies, especially small businesses, your net margin, which is your net income divided by revenue.

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Delegate CFO: it hovers around, say, 5% to 15%. You know, obviously, depending on your industry, you could have a larger percentage, but it’s really the percent of net income

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Delegate CFO: Divided into sales is your net margin.

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Delegate CFO: And in this particular situation.

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Delegate CFO: It’s equal to 5%, the net income of $50,000. Well, that’s 5% revenue right there.

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Delegate CFO: And the more important thing to consider is

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Delegate CFO: When an employee steals from you, even though that previous slide… previously slide said that it was 5% of revenue.

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Delegate CFO: A lot of times, they’re stealing your net income.

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Delegate CFO: Because, at the end of the day, you still have to pay for your cost of goods sold, so you have to pay for your inventory, you still have to pay your operating expenses, so you got your rents, you know, interest on your note, etc. You still, as an owner, have to pay that. So when they’re stealing 5% of your revenue, they’re really stealing your net income.

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Delegate CFO: On there. And another way to think about this is…

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Delegate CFO: when somebody steals from you, again, they’re more or less stealing from your net income. We’ve established that part.

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Delegate CFO: For you to recover those funds that they stolen, you have to have the amount of embezzlement.

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Delegate CFO: divided by the net profit margin. In this case, $50,000 divided by 5%, it’s going to be a million. So just to recover the amounts that they stole, you’re going to have to recover, or have additional sales on top of everything else of a million dollars. So let’s go back to our previously slide.

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Delegate CFO: again, I won’t read the whole thing, but where she said, some of the owners were using their own money to keep their business afloat, believing the company wasn’t profitable, when all the while the problem was Ramos embezzling the funds.

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Delegate CFO: Again, that 5% of sales.

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Delegate CFO: In this particular situation, this Ramos lady, she was stealing from the net income.

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Delegate CFO: And I’ve seen this several times.

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Delegate CFO: Where owners of a company, where they had embezzlement.

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Delegate CFO: they had to fund the company. They had to do a capital call, or had to take out a line of credit. And so, a lot of times, they don’t know that they’re being stolen from.

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Delegate CFO: And again, like in this situation, this is not uncommon, where the company thought they weren’t profitable. In reality, it was just that lady was stealing the funds. And again, when you see that number, 5% of revenue.

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Delegate CFO: You need to think of it more of.

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Delegate CFO: that’s all the net… they’re stealing from your net income. And however much they stole, I then need to take my profit margin and divide that into that respective number. And so, going back.

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Delegate CFO: To calculate, again, just to reiterate, to calculate the amount of revenue needed to recover stolen funds, you need to take the total funds embezzled and divide by your net profit margin. And again, embezzle funds, divide by net profit margin. Key point here.

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Delegate CFO: If your net profit margin is lower.

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Delegate CFO: Then, say, standards say it’s 2%.

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Delegate CFO: then you’re gonna need to generate much more sales to make up for that cash investment. So, conversely, obviously, if you have a very high net margin percentage, then you won’t have to bring in as much sales, but you’ll still have to bring in that. And

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Delegate CFO: when I’m saying bring in more sales, this is above and beyond what you’re already budgeted. So in this, you know, in our previous slide, we look at that, you know, if…

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Delegate CFO: This lady stole, or this person stole $50,000, and that’s their net margins, 5%, so obviously they need to generate a million dollars just to make up that revenue.

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Delegate CFO: Let’s say they already budgeted for the year for 2024 $1.5 million.

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Delegate CFO: So that means for them to get back to where they originally wanted to be at the end of 2024,

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Delegate CFO: They have to have $2.5 million in sales, and that’s just to get to the cash basis that they were projecting to have.

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Delegate CFO: Because keep in mind, when you do your budgets and your cash flow, you’re budgeting actual cash coming in to more or less pay for the company, pay for expenses, etc. Again, goes back to this slide. Company wasn’t believing they were profitable, because she’s stealing from the bottom line, so…

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Delegate CFO: That is a key point to understand, is when you see something like statistics of 5% revenue.

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Delegate CFO: That lady or those people are stealing from your respective bottom line.

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Delegate CFO: So… fraud. Now.

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Delegate CFO: You’ll hear the term fraud triangle, so if you go into Google or type in fraud triangle, you’ll actually see all sorts of images of, literally, triangle.

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Delegate CFO: And what the premise of the fraud triangle is, is you need all three sides of the triangle to have fraud happen. A lot of times when you see the picture, you’ll see the…

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Delegate CFO: The pyramid, and then you’ll see fraud stuck in the middle.

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Delegate CFO: A better way to think about it is, instead of a triangle, think of it as a three-legged stool.

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Delegate CFO: So, in order to get, you know, and if we say the seat itself is actual fraud. So, in other words, the half fraud happen, we need those three legs.

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Delegate CFO: And the three legs of a fraud triangle, or three-legged stool, are motivation pressure, rationalization, and perceived opportunity. Now, you’ll hear different descriptions of it, but these are really the three key areas.

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Delegate CFO: Motivation and pressure

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Delegate CFO: That is usually when somebody feels like, you know, they have a lot of medical bills, so they need to get those covered, or, you know, they want to stay at the country club with all their friends, but it’s very expensive, but they don’t, you know, they don’t want to be on the outs with all their friends there at the country club.

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Delegate CFO: Or, you know, all our friends are going to Vegas, you know, once a quarter, and so they feel like they want to go to that.

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Delegate CFO: There’s usually some sort of motivation or pressure behind somebody who commits fraud. You know, there’s something there that’s causing them to want to do that.

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Delegate CFO: Rationalization.

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Delegate CFO: Rationalization is predominantly

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Delegate CFO: if I’m an employee, and I feel like I worked a ton for the company, but they didn’t give me a bonus. Well, I may rationalize, I deserve a bonus because I work harder than so-and-so, or I deserve a pay raise because I’m actually doing two jobs, you know, when so-and-so left.

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Delegate CFO: So, rationalization is how somebody rationalizes they should commit fraud because of XYZ instance.

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Delegate CFO: And the last item, perceived opportunity. Now, perceived opportunity is where this, is where you have internal controls.

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Delegate CFO: If I’m a scrupulous person, and then I’m trying to steal, and I know that the owner never looks at the bank statements, never looks at the income statement, just occasionally shows up, you know, writes himself a check for disbursement, he’s not really there, nobody really looks over that.

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Delegate CFO: in my mind, if I’m committing fraud, I see there’s an opportunity here, because nobody’s going to catch me. Nobody’s looking at my work or anything like that.

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Delegate CFO: And so that’s really where the internal controls are. So, back to the three-legged stool. You need all three of these items to have fraud happen.

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Delegate CFO: Now, you can’t control the motivation and pressure.

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Delegate CFO: You know, somebody’s wanting to be at the country club with their friends, you can’t control that.

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Delegate CFO: Rationalization. Now, you can talk to an employee about how, you know, great and valuable they are.

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Delegate CFO: But you can’t control how they’re rationalizing, hey, I should have a bonus, or I should get paid more than so-and-so type situation. You can’t control that.

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Delegate CFO: But you can’t control perceived opportunity, and that is your internal controls. So if you control that perceived opportunity, you more or less have removed that leg on a three-legged stool, and what happens?

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Delegate CFO: it falls over. And so… and then you don’t have fraud happen. And so that’s why it’s key, even though when we talk about fraud triangle, I can think of it as a stool, and the one area that you can definitely control is your… the perceived opportunity. So, let’s get into…

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Delegate CFO: The main basis, or the main, foundation for internal controls.

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Delegate CFO: So, a lot of you have probably heard that

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Delegate CFO: With internal controls, you have what’s called segregation of duties.

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Delegate CFO: And segregation of duties is really broken down into four main areas. Authorization, custody, recording, and monitoring.

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Delegate CFO: Now, authorization, just like the name says, that’s the ability to authorize a transaction, whether it’s authorized to sign the check, or authorized to, do a purchase agreement, or purchase product from a vendor, you have some sort of ability to authorize a particular transaction, or even sign a lease agreement.

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Delegate CFO: Custody of assets. Again, 20 years ago, this was predominantly centered around who has custody of the actual checkbook.

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Delegate CFO: But today, it’s really who has access to the bank statement, electronic funds, or EFTA funds, who has access to the actual physical documents.

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Delegate CFO: Who has access to the… by physical documents, the actual checks, and who collects payments? You know, that’s an asset. So who has custody of these particular assets?

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Delegate CFO: Recording, again, who records the transaction into the accounting records? You know, into QuickBooks Zero, what have you. Who does the actual recording of the transaction in there? And then monitoring.

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Delegate CFO: Monitoring is where you’re reviewing

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Delegate CFO: all the processes, you know, reviewing that transaction, is this transaction correct? Reviewing that journal entry. You’re monitoring and or reviewing the bank reconciliation. So you’re performing a review level. You’re not doing all these particular steps, but you’re going back and reviewing all that. Now, of all these duties.

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Delegate CFO: Let me take a step back.

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Delegate CFO: In the textbooks that you see in college, they always say that you have one person in each one of these areas. One person does authorization, another person has custody, recording, monitoring.

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Delegate CFO: In the real world, that’s not feasible for small and medium businesses. You can’t afford to have literally one person in every single area. Now, as a small and medium business, a lot of times, some of these duties are intertwined with the same person.

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Delegate CFO: However…

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Delegate CFO: as the owner, executive management of your company, that monitoring function should never leave your, grasp. You should be the one that does that. Not only has the ability to do it, but you should be doing it consistently. Because most frauds that you see, again, if you go and type in bookkeeper fraud.

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Delegate CFO: If you read those stories.

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Delegate CFO: one, I suggest you look at this particular slide when you read those stories to see, you know, okay, who had authorization, who had custody, etc.

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Delegate CFO: But the monitoring is usually why that fraud happened, because they were… the controls were not being monitored, cash wasn’t being reviewed, bank statements weren’t being reviewed. And so, of all these controls.

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Delegate CFO: That monitoring function should stay with you, the owner, or executive management.

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Delegate CFO: No.

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Delegate CFO: Again, like we just mentioned, if one person has access to all four areas of the segregation of duties.

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Delegate CFO: Then the business will be ripe for fraud.

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Delegate CFO: Go back, do your Google search.

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Delegate CFO: I can almost guarantee every single one of those, there was a situation where that person had access to all four, or they had access to three, but the monitoring was never being done by the other person, so…

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Delegate CFO: de facto, they had access to all four. So, if somebody has access to all four of those items, you are heavily ripe for fraud in your organization.

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Delegate CFO: So what are internal controls?

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Delegate CFO: Internal control is really…

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Delegate CFO: Are going to be your policies, procedures, and systems that you have to protect your assets.

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Delegate CFO: One way to think about it, and I’ve done presentations before for businesses that are going through incubation centers.

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Delegate CFO: is… imagine if you took your wallet. You know, let’s say you have, you know, $500 cash in there, you’ve got several credit cards in there. Would you take your wallet, if you were, like, in a classroom setting.

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Delegate CFO: Put it down on a desk, walk away for a couple hours, and then come back and expect all your cash to be there, your wallet to be there.

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Delegate CFO: Probably not, and you probably wouldn’t do that.

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Delegate CFO: That’s the same thing that happens with your business when you don’t have controls in place. You’re really doing that.

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Delegate CFO: And so, back to what are internal controls. They’re really policies and procedures designed to protect your assets. You know, they’re designed to prevent or detect and respond to errors or fraud. And errors do happen, so don’t… anytime something is out of whack.

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Delegate CFO: Don’t immediately assume fraud, because sometimes they’re, you know, we’re all human, so we, you know, could mispost something.

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Delegate CFO: The key elements, obviously, are the segregation of duties, authorization process, checks and balances. So, back to that first bullet point.

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Delegate CFO: Policies, procedures.

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Delegate CFO: You want to make sure you detail out that, because a lot of times what you’ll find is if you have to write out a memo saying, you know, this is what this person does, this is what that person does, you start realizing.

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Delegate CFO: Jane actually has access to all these areas, and you don’t really realize that until you start printing it out.

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Delegate CFO: But when you put those policies and procedures in place, you then set up the structure for your company, because all companies have turnover, even in your county department. You know, people retire, lead to another job, termination, what have you.

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Delegate CFO: When you bring that other person in, you want to have those policies and procedures in place to be able to identify, or be able to have them know what their control processes are.

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Delegate CFO: And just a side note, on my forensic side of my company, when I do an investigation.

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Delegate CFO: one of the first things I do, I mean, obviously, there was an incident that happened for, you know, the particular companies to give me a call to begin with.

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Delegate CFO: But one thing I’ll do is, I will just sit down with them, and I’ll just document what their controls are, in just a memo form.

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Delegate CFO: reason being is that will then lead me to understand, okay, there’s a weakness here, you know, this, you know, Jane had access to the cash, you know, didn’t, you know, no bank recs were done, nobody monitored that, so I’m looking at cash.

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Delegate CFO: Whereas, you know, Fred may be doing the payroll, but Jane was HR, and she did the payroll rates, but Fred just did the payroll. I might not be as concerned on ghost employees on that situation, so…

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Delegate CFO: Writing it out will help you identify where your weaknesses are, and then you can, from there, start molding what your controls need to be.

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Delegate CFO: Now, what is the cost of doing nothing?

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Delegate CFO: Obviously, as we already noted, Lost that income.

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Delegate CFO: People steal from you, they’re gonna steal from your bottom line. So, right there, there’s lost net income.

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Delegate CFO: The other cost? Attorney fees.

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Delegate CFO: So you catch somebody committing fraud.

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Delegate CFO: odds are you’re probably going to go after them civilly. Hopefully, you also go after a criminal, and we’ll talk about that in a second, but if you’re going after civilly, you’re going to need to go and get an attorney, preferably one that can do litigation, and you’re going to have costs for the attorney fees.

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Delegate CFO: forensic accountant. You’re going to have to pay for an expert to go through, because if you go to court, obviously, civil, you need to have some sort of report indicating, here’s the total amount of

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Delegate CFO: Funds that were stolen, this is how she did it, this is, you know, over this time span, etc, etc. So you have to pay for a forensic accountant to go through there.

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Delegate CFO: So those are all just actual monetary fees. Now, you’ve got your own time spent on investigation, meetings, court dates. You know, you’ve got to meet with the attorney to go through it, so that’s time out of your day. You know, you’ve got to meet with… if you’re doing criminal, you’ve got to go down to the police department and meet with the detective, so that’s time out of your day.

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Delegate CFO: We go to court.

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Delegate CFO: Both civil and criminal, you know, you’re probably going to be in court for a while, so all that takes up time, not only the actual meetings themselves.

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Delegate CFO: But a lot of times, you have to prep for those meetings, and so you’re going to have that as well. So all that is just your own personal time that you could be spent working on the company. You’re now being spent on doing this. Possible lost revenue and opportunities. Obviously, you know, lost revenue could be if…

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Delegate CFO: the bookkeeper was stealing accounts receivable, and you call up your best customer and say, ask them why they haven’t paid, and in reality, they actually had paid, and you just alienated your best customer, and they might not do business with you again. So, you know, there’s always that possibility. And then, of course, opportunities.

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Delegate CFO: You know, if they’re stealing from you, again, they’re stealing your net income, so you don’t have that extra cash to, you know, expand your warehouse to be able to offer more products or…

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Delegate CFO: quantity of product, or hire that next programmer to come in for your SaaS company, you’re going to lose those opportunities, because you just don’t have the cash to be able to do that. Personal assets.

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Delegate CFO: Now, I’ve seen this a number of times, if you recall back on our previous slide, let’s go back to that real quick, on, …

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Delegate CFO: that quote.

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Delegate CFO: Where it said.

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Delegate CFO: But even the company was profitable, when all the while, the problem was Raimel’s investment funds. You know, the owners were putting their own personal money in there.

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Delegate CFO: I have seen a number of times where a particular owner,

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Delegate CFO: Has had to sell their own personal assets to keep their company going.

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Delegate CFO: They believed their company was failing, they didn’t want it to fail, so they had some investment assets, I believe it were rentals that they ended up selling. I think one guy ended up selling his boat, selling a car, you know, so that then they had the funds to keep their company afloat.

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Delegate CFO: And this is all because a fraud happened. In this particular situation, this individual, this owner, had had this personal asset in the family for quite some time, and ended up having to sell it.

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Delegate CFO: And he shouldn’t have had to sell it, because this lady had stolen from him. And recovery is highly unlikely. This is part of the cost of doing nothing.

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Delegate CFO: Most of the time, from what I’ve seen, is when an employee embezzles, there’s a particular employee embezzlement.

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Delegate CFO: They usually use the money on items that aren’t tangible.

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Delegate CFO: And by that, I mean they’ll take a trip to Italy. You know, they’ll go on a Caribbean cruise. They’ll go to Vegas and gamble a whole bunch.

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Delegate CFO: So they’re using all that money, but they’re not buying physical assets. It’s not like they’re buying Bitcoin or real estate. They’re just using it and blowing it on stuff that can never be recovered. And then conversely, if they do buy an asset.

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Delegate CFO: Oddly enough, they don’t take good care of that asset. So I’ve seen situations where individuals bought, you know, either high-end pickup trucks or luxury cars.

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Delegate CFO: And they just didn’t take care of it. It was just all beat up by the time we got to the fraud and collections standpoint.

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Delegate CFO: And…

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Delegate CFO: I… just based on the small sample I’ve seen, for some reason, when people commit fraud and they buy a personal asset, I believe it’s probably because it’s… they weren’t… they didn’t have to earn the money to get that asset, so they have very… they don’t care for the asset as well as most people would.

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Delegate CFO: So, that’s one of the things to keep in mind. Again.

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Delegate CFO: They may have bought a physical asset.

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Delegate CFO: But it’s probably all torn up. So, recovering of what they stole is very highly unlikely. Again, you can get a judgment and start collecting, but

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Delegate CFO: how much you’re going to collect and how long that period is, that’s going to be up in the air. One thing I will add to this, it’s not on this slide.

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Delegate CFO: Usually when… You catch somebody committing fraud, embezzlement.

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Delegate CFO: they will only admit to what they think you know. And I’ve seen statistics that

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Delegate CFO: Usually, you know, whatever they tell you, you need to multiply that by, I believe it was, like, 5 or 6.

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Delegate CFO: Because they’re not gonna admit to the full amount. They’re only going to admit to what they think you know, that they stole.

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Delegate CFO: The other aspect is, and I’ve seen this before, sometimes I don’t even know how much they stole. You know, I had one case where an individual had been stealing from this company for at least 12 years, probably more. We didn’t have enough records to go back any further.

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Delegate CFO: And it was multiple transactions each month, sometimes one month it would be a couple transactions, sometimes, you know, it would be up to, you know, 14 transactions in a month. So this happened over years and years and years, and one of the things I had informed the detective, because this was going through criminal.

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Delegate CFO: is this individual probably doesn’t even know how much they stole. And again, same thing, is they blew a lot of it on stuff that wasn’t tangible. So, the owner is probably not going to collect, or is going to collect pennies on the dollar. So again, this is all the cost of not doing anything with your respective internal controls.

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Delegate CFO: No.

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Delegate CFO: Excuse me, core internal controls every small business needs.

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Delegate CFO: And actually every business, but in particular small businesses.

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Delegate CFO: Bank reconciliations, they need to be done and done timely.

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Delegate CFO: I actually had a case once where

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Delegate CFO: But it was a bookkeeper for kind of a smallish company, and again, they didn’t monitor her. She ended up, you know, she was committing embezzlement.

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Delegate CFO: But she had never done a bank wreck.

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Delegate CFO: And they never said anything. And we had came in, and we actually weren’t doing a fraud investigation, we were just doing a financial statement audit.

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Delegate CFO: And we can never get the bank wreck. And this had been going… apparently, this has been going on for years. And finally, we got the bank wreck, and there were all these errors in it. And, you know, we just kept asking, why are there errors? And again, that’s eventually where it fell out, that there was, embezzlement.

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Delegate CFO: But if she had been doing the bank rec, or, you know, been doing the bank rec, and timely, and it had been monitored, this would have all been caught, pretty quick. Again, unfortunately, this was one of those situations, and it’s not uncommon that,

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Delegate CFO: the ownership terminated her, I think they went after her civilly, but they didn’t press, criminal charges, and that’s not uncommon.

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Delegate CFO: when criminal charges aren’t filed. Again, that’s…

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Delegate CFO: Due to reputation risk, they don’t, you know, the company doesn’t want to be in the local paper, all that. My recommendation, especially when I take on a new client or a new forensic case.

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Delegate CFO: Is that you prosecute. If there is, obviously, fraud there, that you move it to the criminal aspect, because if you don’t.

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Delegate CFO: person’s gonna do it again, and with all how HR rules are, I believe you can’t tell, you know, the new employer that you fired, you know, Susie because she committed fraud. So, unless there was a criminal charge. So that’s why I always say, if you’re going to do it, make sure you file criminally.

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Delegate CFO: So, other internal control. Many audits done monthly, so…

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Delegate CFO: For our CFO clients, we do mini-audits every month, regardless. And what a mini-audit is, is you take the balance sheet, and you tie out each of those accounts to source documents. So again, cash is going to be the first line item of your balance sheet, should tie out to your bank statement and your bank reconciliation, that should work.

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Delegate CFO: accounts receivable, that should tie out your AR subsidiary ledger. Those two should tie back and forth. Obviously, review your AR subsidiary ledger, make sure there’s old stuff on there that, you know, isn’t suspect. And you go through that, so everything is getting tied out.

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Delegate CFO: And this is actually what we did for one of… we had a client that was a small not-for-profit that had hired a lady to be the controller, but she really didn’t have controller experience.

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Delegate CFO: And so this is literally what we had her do each month, was a mini-audit. And by that is, you know, she just had an old physical binder, she’d print out the trial balance.

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Delegate CFO: Not each of the things, you know, so the bank rec would be your first item right behind the trial balance, and then she’d have her AR subsidiary right behind it. So everything was supported, so she was doing this mini-audit every month. And again, when you do that, if any kind of fraud is happening and being hidden on the balance sheet, it’s going to fall out very quickly.

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Delegate CFO: physical security of assets, including electronics. And by electronic, what I’m talking about is bank statements, and in particular wires, ACHs, those type things.

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Delegate CFO: dual authorization for payments. Again, for certain levels, a lot of companies require dual authorization, and especially on wires, you know, that should have a dual authorization on there that, you know, the person initiates it, and it can’t go through until the owner comes in and signs off as well.

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Delegate CFO: And budget to actual, and as you see there, hint, this is extremely important.

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Delegate CFO: Obviously, you need to have a budget in place, and if you need help with a budget, give us a call. We’ll help you put a budget together for your company.

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Delegate CFO: But every month, you need to do a budget to actual.

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Delegate CFO: Because a lot of times, that is one of those monitoring functions that, a weakness will pop out very quickly. Because let’s say office supplies… let’s say you budgeted $20,000 for the year for office supplies.

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Delegate CFO: We’re in June, and you’re already at 30,000, so you have a 10,000 delta, and you’re only halfway through the year.

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Delegate CFO: that’s going to spark your interest, you’re going to dig down further and find out, okay, why do we put $30,000 in there when we only budgeted 20 for the entire year? And so then that becomes one of your monitoring control functions. And again, this is huge for internal controls.

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Delegate CFO: If you go back and look at a lot of the videos on Elon Musk when he was doing the Doge, issues.

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Delegate CFO: One of the things he noted in one of his interviews

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Delegate CFO: was the lack of budgets in the, some of those federal departments. Well, if you don’t have a budget, how do you know you’re going to be over budget, under budget, and expenses authorized, if you’re not being able to compare it to something? So, that’s why we say budget to actual is extremely important, control with your small business.

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Delegate CFO: So, how do you implement this?

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Delegate CFO: Again, assign responsibilities so no one person handles a transaction from start to finish. Again, segregation of duties, those four areas.

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Delegate CFO: That one person should not have access to all four areas. Use accounting software, permission settings, and logins.

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Delegate CFO: And you’ll see that logins is underlined. First, the permissions. Obviously, you have an AP clerk, they really should have no reason to have access to AR, or the AR clerk shouldn’t have access to AP. So, you obviously set up the permissions correctly.

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Delegate CFO: The other aspect is logins. Now, unfortunately, with QuickBooks, the standard login, user ID is admin.

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Delegate CFO: That becomes a problem when there’s fraud that happens, because as a forensic accountant, trying to prove that John was the one that stole this money.

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Delegate CFO: it becomes a little difficult, because you go into the transaction to see who posted it, and it just says admin. And so…

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Delegate CFO: defense will come back and say, well, anyone could have done that, it’s admin. So that’s why your logins need to be specific to that individual. So John has his own admin, Susie has her own ad… or login, sorry, not admin, login.

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Delegate CFO: And all those transactions are tagged with that respective information. And so that’s why it’s key that you put those names in there. Again, if you just do admin, it makes it more difficult to prove

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Delegate CFO: That respect of fraud, no.

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Delegate CFO: there’s workarounds for it, but it makes life so much easier if you can go in and see that, you know, John went and modified this transaction at 6 PM,

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Delegate CFO: You know, when the company closes at 5, you know, and it’s, here’s his login, here’s the timestamp type situation. So that’s why you want to make sure that each person has their own specific login to their name.

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Delegate CFO: And make sure nobody knows anyone else’s login and passwords. You know, those passwords should remain with your IT. If you don’t have an IT department.

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Delegate CFO: HR, just make sure HR doesn’t have access to the county records, and then you’ll have controls there, because I have seen situations where an individual that was committing embezzlement had access to other logins and was using those logins, to further their embezzlement.

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Delegate CFO: Require management approval for purchases over a dollar, certain dollar amount, again.

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Delegate CFO: You need to, obviously, you know.

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Delegate CFO: Set the dollar amount, but, you know, if the purchasing manager

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Delegate CFO: you know, is making a $150 supply purchase, you probably don’t need to have manager approval on that now. It’s $150,000, yes, so you need to determine what approval level you need that, one, doesn’t hinder the business, but two, provides control for your company.

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Delegate CFO: Again, can’t stress this enough.

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Delegate CFO: review the bank statements monthly, and by bank statements, I also mean the bank reconciliation.

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Delegate CFO: If you don’t know how to do a bank reconciliation or what it’s telling you, there are a number of videos there, or you can even contact us, because it’s very important you understand what’s going in and out and how that bank reconciliation works.

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Delegate CFO: Now, maybe if you’ve never done one before.

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Delegate CFO: maybe kind of a struggle the first month or two, but once you understand it, it’ll be very quick and easy for you to be able to review that. But again, if you’re not reviewing that, it’s going to be very hard to catch fraud, because keep in mind.

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Delegate CFO: Almost everything in your financial statements pivots around the bank account.

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Delegate CFO: If you think about that, that’s going to be your cornerstone for pretty much everything else within the financial statement. So you need to make sure that number is correct and tied out and understood, before you start breaking down everything else.

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Delegate CFO: Inventory counts, obviously do surprise the schedule. If you have valuable inventory that could be stolen. Again, surprised ones are key. You should be doing schedule counts regardless of this, because you need to understand what your order point is, how much you need to order, etc, etc.

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Delegate CFO: But if you’ve got valuable inventory, you need to make sure you’re doing those counts on a surprise basis. And if you want to see something rather impressive, if you look up one of the diamond companies, like Debris, you look at them.

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Delegate CFO: and look up their controls. I won’t go over them, but they’re just, like, you know, because a diamond is highly valuable and teeny tiny, they have very, very specific controls, and it’s just eye-opening, and it makes sense, but it’s just eye-opening when you read those controls.

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Delegate CFO: Now, red flags, warning signs, again, unexplained cash shortages. Back to that quote we had in that, story.

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Delegate CFO: The company, the owners thought they weren’t making money, so they had to put cash in.

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Delegate CFO: Unexplained cash shortages hit. And again, this also goes back to your budget, you know, because you’re… when you’re budgeting your… and most people were budgeting their income statement.

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Delegate CFO: If you’re not hitting those budgets, obviously that’s going to impact cash.

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Delegate CFO: And that’s another budget to actual that you’ll have, is, okay, this is what I expect my cash runway to be, and why did that runway all of a sudden go from

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Delegate CFO: say, 18 months, now it’s retracted to 12 months. And again, that’s going to be part of your monitoring function, but any unexplained cash shortages that require, oh man, I need to put in cash now, that needs to be a red flag. Now, one caveat to that

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Delegate CFO: If you’re in an industry that all of a sudden your sales are just rocketing up.

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Delegate CFO: you get into that weird situation where you have a ton of sales, but because of collection procedure, you know, you may sell to, say, Walmart or whoever, and so your sales have gone from, say, $10 million, now you’re up to 15 million, and it’s just rocketing up.

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Delegate CFO: But you don’t collect on those sales until later, but you’ve got to pay for all the expenses up front, and so you wind up in kind of a weird cash shortage situation. So that is a situation where you do wind up a cash shortage.

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Delegate CFO: It’s not internal control, it is just because of the projection of your business, but you still need to be able to explain cash shortages.

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Delegate CFO: Excessive voids or credits, again, obviously, if somebody’s voiding transactions.

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Delegate CFO: They may be pocketing cash. Again, this goes back into cash shortages, budget actual fluctuations, again, we’ve gone through that. Missing documents, you know, that’s obviously a red flag. You know, if you have a vendor invoice that, you know, you paid the vendor invoice, but just so happens that particular vendor

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Delegate CFO: You can’t find the invoice for, but you have the invoice for everybody else. That’s a huge red flag.

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Delegate CFO: Employees who never take time off.

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Delegate CFO: Now, this is mainly centered around the accounting staff.

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Delegate CFO: Or, also inventory, personnel.

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Delegate CFO: The reason why they don’t take time off, because they know

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Delegate CFO: that their fraud has gotten to a point that if they do, it’s gonna unravel, or it’s gonna be discovered fairly quickly. And again.

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Delegate CFO: Another way around this for those employees that commit fraud, they may take time off.

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Delegate CFO: But they make a big show of, well, don’t let so-and-so into the records, because they’re just going to mess it up, and it’ll take me forever, so…

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Delegate CFO: I’ll fix that when I get back, or I’ll, you know, keep doing the accounting, you know, I’m gonna be gone for 2 weeks, but I’ll keep doing the accounting when I get back. Don’t let… don’t let John into the records.

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Delegate CFO: That’s a way they get around that, you know, not taking time off, because they want to take time off, but they also don’t want you to discover their fraud.

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Delegate CFO: But, if you have employees that aren’t taking time off, that’s a huge red flag. Now.

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Delegate CFO: I will admit, I did have a situation where this individual didn’t take time off for years and years and years.

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Delegate CFO: And it came about that they were actually using their PTO as kind of a retirement vehicle, because if you think about it.

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Delegate CFO: You know, if you have, say, 80 hours of PTO, each year you get a raise, let’s say you get 5% raise, well, you’re making 5% on the 80 hours that you, you know, had banked, you know, several years ago.

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Delegate CFO: And then she was also getting more hours, so it was adding on to that, so it just compounded. And so her… her PTO, I think, got up to, like, $50,000.

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Delegate CFO: We ended up fixing that situation, but that was one of the rare times where somebody didn’t take time off, and it was strictly because of… they were using it as another aspect for the retirement.

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Delegate CFO: And vendors with similar addresses and employees, obviously you do not expect a vendor to literally have the same address as employees. The other thing to keep in mind is.

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Delegate CFO: If you want to, and this is kind of, …

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Delegate CFO: back in control. Review your vendor lists at least quarterly, just print it out and go through it. Reason being is…

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Delegate CFO: there’s another type of fraud that is external fraud that can hit you, so if…

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Delegate CFO: Let’s say you were doing business with ABC Company, and that was, like, 3 years ago, and you haven’t done business with them, but they’re set up in your system.

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Delegate CFO: you know, there could be an unscrupulous person at ABC that says, well, I’m going to send an invoice to them and see if they’ll actually pay it. And that actually does happen. Actually, I think it happened to a very large company, like IBM or one of them.

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Delegate CFO: Where a vendor just sent an invoice just to see if the company would pay it. And so that’s an external fraud. Now, the internal fraud is where you have… let’s say you have ABC, and let’s say it’s called ABC Company.

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Delegate CFO: And then somebody goes in and makes ABC Companies and puts an S at the end. You know, they intentionally misspell it.

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Delegate CFO: you as an owner, you know, maybe signing checks, you see it, you don’t catch that, you know, there’s an extra S on it. Just sign the check, send it out. In the meantime, that employee has just set up a fake bank account to cash it, so it says ABC’s company.

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Delegate CFO: And then they pocket the cash. So, again, you want to review your vendor list to make sure there’s not any unusual… one, there’s not unusual vendors, and two, any vendors you haven’t done business with, you want to either terminate or discontinue that vendor in the system so that if a fake invoice comes from them.

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Delegate CFO: It’s immediately gonna pop up, and everybody’s gonna take a second to take a look at that, so…

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Delegate CFO: Let’s go ahead and go into… R.

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Delegate CFO: Q&As, take a look here. So, we’ve got… Several questions here.

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Delegate CFO: go ahead and take a look at some of these questions. Give me one second.

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Delegate CFO: Okay, so these are pretty good questions here. So…

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Delegate CFO: A three-person office… let me move this…

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Delegate CFO: 3-person office, net 120 clients, how do I make… no one has time.

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Delegate CFO: compatible with segregation of duties. …

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Delegate CFO: again, first thing is somebody steals from you, they’re gonna steal from your bottle of wine, so that’s one of the keys. But…

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Delegate CFO: you need to make sure that the monitoring function is separate from all the other. You know, if you’re a three-person office.

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Delegate CFO: My guess is you’re having to have people do multiple tasks in multiple areas. You just need to make sure you mitigate that by taking the monitoring function, and that is with the ownership, executive management. You know, don’t let

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Delegate CFO: If you’re just using one of those people, don’t let them do all of it. And again.

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Delegate CFO: That quote of, no one has time, you still have to get your, you know.

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Delegate CFO: Billings done, bills paid, you know, income-end type situation. So you still have that that has to go on. So just make sure that that monitoring function stays outside of the purview of the individuals, which is probably going to be doing multiple areas of the segregation issue.

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Delegate CFO: If the CPA who does our taxes is also our outsourced CFO,

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Delegate CFO: Does that satisfy independent review, or do we need a different set of eyes on the bank rec?

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Delegate CFO: Well, first, Yes, that satisfies the independent review. They’re really going to be producing and doing the bank rec.

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Delegate CFO: And I’m assuming they are the ones doing it, or they’re reviewing it, the bookkeeper’s doing it, and they’re coming in and reviewing it, so…

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Delegate CFO: That is a key control right there. However, I still recommend that you understand what it is they’re reviewing, how they reviewed it, and they go over that with you. Because this is your company, and you really want to understand this.

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Delegate CFO: And, you know, if for some reason you expand and you become a larger company, and all of a sudden you need an actual on-site CFO, you can’t do the outsourcing anymore, because it’s just, you know, the sheer volume of everything that’s going through.

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Delegate CFO: you want to be able to understand those, bank reconciliations. So yes, it is good that they’re doing that review and it’s independent, but you still want them to go through and train you on what this is and what they’re looking at.

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Delegate CFO: We file taxes cash basis, but someone told me that gives embezzlers extra months to cover the theft.

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Delegate CFO: Should we switch to accrual just for internal reporting, even if we stay cash basis for the IRS?

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Delegate CFO: So, there’s a couple things in that particular question. First, you should always be accrual basis. You know, obviously, if you file your taxes cash basis, you know, if you go into QuickBooks.

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Delegate CFO: literally at the top, you know, when we print out the balance sheet, it has, you know, you can click the button cash, or click the button accrual. You always want to be accrual, because

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Delegate CFO: Technically, a true cash basis person would never have accounts receivable if you went to the true cash basis.

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Delegate CFO: Now you’ll have tax accountants out there saying, well, we do a hybrid.

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Delegate CFO: that’s just accountant speak for… we’re cherry-picking the accounts that we want to recognize, i.e. AR, but we don’t want to do accrual payroll type situation, so…

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Delegate CFO: Being a cruel basis is, you know, first, the key.

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Delegate CFO: And then the other part to your question about, someone told me it gives embezzlers extra much to cover the theft.

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Delegate CFO: If you’re not reviewing… or actually, there’s two aspects. One, your tax account will not catch fraud. They are not…

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Delegate CFO: Tax accounting is not designed to catch fraud.

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Delegate CFO: If you think about it, at its core level, a tax accountant does data entry. They take your data, they put it in the tax software. Now, they have to understand where it should go, what is and isn’t deductible, so on and so forth.

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Delegate CFO: But for the most part, they’re doing data entry. They’re not going through and reviewing it. Now, if they happen to find fraud, it’s probably because they happened to stumble upon it, but they’re not looking for it, and they’re… they don’t have tests designed to look for it.

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Delegate CFO: So that’s also important to note, that even though you have a tax account, they rarely will identify fraud and fine fraud.

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Delegate CFO: But the other aspect to that, where you mentioned,

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Delegate CFO: Gives embezzlers extra months to cover the theft.

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Delegate CFO: you need to be doing your monitoring monthly. You can’t do it at the end of the year, because again, you know, if you remember that slide we saw at the beginning, you know, the average fraud isn’t detected for 12 months.

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Delegate CFO: In this situation, if they happen to commit fraud in January, that would literally be 12 months of fraud going on without being detected. So you’ve got to do your controls every single month, again.

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Delegate CFO: Controls break down to doing your mini-audit.

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Delegate CFO: Looking at your bank recs, you know, looking at your budget actuals. You’ve got to do that monthly. Once you start doing that monthly, again, it gets easier. Again, all this control stuff that I’m mentioning.

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Delegate CFO: this is what our CFO company does for our clients, you know, and I believe we’re one of the few, if not the only, company that has forensic accounting as part of our CFO package.

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Delegate CFO: And then, running out of time, so the last question was just one more here. Lease copier, or… lease a copier or buy one outright. The rep claims lease auto bills quarterly and nobody checks. Could that be a place to bury a fraudulent vendor?

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Delegate CFO: Yes, you could bury a fraudulent vendor. However, It would be caught…

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Delegate CFO: If, you’re doing your budget to actual. This is actually a good thing to discuss on budget to actual.

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Delegate CFO: with your lease, or any lease, you pretty much know what your payments are going to be. So that budgeting part is pretty easy. You know, so I got a $1,000 a month lease payment, or, you know, in this case it’s quarterly. I got $5,000 every quarter that I have to pay.

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Delegate CFO: If your company buys the comp here.

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Delegate CFO: or outright purchase it, then all of a sudden you see a lease payment, that’s gonna show up instantly like a red flag, because when you get to that end of Q1, where the payment comes out.

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Delegate CFO: You’re gonna look and see, okay, here’s this lease payment for $5,000, and I have a budget of zero. Why is that?

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Delegate CFO: Then you’re going to go ahead and dig into that respective item.

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Delegate CFO: Hopefully, you’ll see, okay, why did we just pay the copier lease company $5,000 when we actually bought this?

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Delegate CFO: And then you start going down the road. Now, there may be kickbacks on the other side of that, who knows what the other aspect of that is, because

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Delegate CFO: when employees commit fraud, they want the cash out of the company. So you gotta think, how are they gonna get… how are they gonna benefit from this? Usually in this situation, if it goes to the copy machine, or copy, company, or machine… copier, company, it would probably come back as a kick map. So…

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Delegate CFO: Again, budget to actual is really key on this respective aspect.

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Delegate CFO: So, again, run out of time, so we’ll just kind of jump to the second last slides. Again, if you need help with any of this, please feel free to book a complimentary internal control consultation with us.

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Delegate CFO: We’ll go through that, and we can pretty quickly identify what your weaknesses are. Now, a full and total control review will take a little bit longer.

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Delegate CFO: But we can at least, you know, do a quick phone call and get an idea as to where your weaknesses may or may not be, in respect to the operations of your company.

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Delegate CFO: Again, my name’s Steve Haldman, I’m a CPA, and I’m founder of Delegate CFO. You can reach me at steve at delegatecfo.com.

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Delegate CFO: You can learn more about our company at DelegateCFO.com.

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Delegate CFO: And this is currently being recorded for those of you on live. The recording will be distributed out to you afterwards, as well as the respective materials. And also, one aspect that isn’t here is we will be sending everyone

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Delegate CFO: a quick internal control checklist. It’s very small, it’s like 2 pages, and it just gives you an idea as to, do you have weaknesses currently in your system? And it’s pretty much a yes-no as you go through.

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Delegate CFO: And if you hit certain barometers, it’s going to kick out and say, yeah, you probably need to review your internal control. So we’ll have that, to the people who are watching currently on live. If you’re watching this on a recording, please feel free to contact me. Again, Steve at Delegate CFO,

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Delegate CFO: And I can go ahead and get that sent out to you as soon as I can. So, again, thank you for taking the time to watch this, and I hope you have a great day.