Articles - Org Development

 Lack of Internal Controls

There are several elements of existence that heighten the failure rate of a small business. The first condition is the lack of understanding and utilization of proper accounting methodologies, and the second condition is poor utilization of internal controls. In this article we will cover how and why a small business owner needs to monitor the internal “heart beat” of an operation for maximum profitability, and the consequences of negating the process due to a myriad of reasons.

Entrepreneurs have a keen interest in their significant product; however many times the broader scope of running a company is not their forte. Learning how to run the entire operation is equally or more important than understanding the specific product or service being offered. In analyzing hundreds of companies in the last decade, a common denominator exists: Owners understand what they are selling; they just don’t understand how the process should occur to keep them from losing profits or the entire company.

Let me provide some real world examples I have encountered before I continue:

Situation 1:

A vitamin store owner who has been operating for 34 years consistently grossing 1.7 million per year looses 98K in revenue due to a store manager’s embezzlement in less than 12 months. The store owner nearly went bankrupt and eventually took a second on his house to re-coup the costs. 

Background:

The store manager had worked for the vitamin store for nine years and was a close friend to the store owner. The manager controlled all the inventory purchasing and end-of-day sales reports. Financial problems occurred for the manager and he decided to embezzle everything he could to alleviate his own problem.  

Internal Controls:

The store owner allowed the manager to sign checks, purchase inventory, and complete end-of-day reports, which allowed embezzlement and fraud to occur unnoticed until lack of cash flow became the key issue. At this point the problem was too significant to rectify.

Situation 2:

A furniture store owner operating for 20 years grossing between 4-5 million per year lost 79k in revenue due to the bookkeeper’s embezzlement in less over the course of nine years. The store owner was able to qualify for a small business loan; however it took approximately 22 months for the owner to properly cash flow the company again.

Background:                                                                                                 

The store owner allowed the bookkeeper the authority to sign checks, reconcile the accounts and balance the month end accounting statements. The accountant categorized the embezzled money as payments to the IRS for employee 941’s but made the checks out to a personal account created in Nevada under her own name. The bookkeeper had worked for this company nine years and was looked upon as a “stellar” employee who was highly valued.

Internal Controls:

The store owner was audited by the IRS and found the error for the owner. If the company was not audited, the problem would still be occurring. The owner allowed the bookkeeper total control over the accounts and the problem was too late to rectify or re-coupe the cost. The bookkeeper purchased a high end luxury car with the embezzled money.

Situation 3:

A 78 year-old mechanical shop owner allowed his son to run all the accounting for the company including employee payroll. The company had been operating for 40 years successfully until the owner’s son took the accounting over the last three years. The store owner was audited by the IRS and found he owed over 55k in back taxes for 941’s, with additional interest and penalties. The store owner was too old to re-coupe from the error and had to sell his home and close the business.

Background:

The store owner’s son was an alcoholic who after three years was committed to rehabilitation. The father assumed all accounting was being completed properly, only to find out the money that was to be issued to the IRS was being spent on bar tabs. The son’s wife was a bookkeeper who worked for a large CPA firm and verified the son was correctly administering the monies due properly.

Internal Controls:

The store owner was audited by the IRS and was made aware of the back taxes due after his son was committed to rehabilitation. The store owner’s defense was that he was unaware of the problem, however the IRS requires owners to have full knowledge of payroll taxes regardless if the owner is completing the activity personally or hiring personal to complete the transactions.

These scenarios happen on a daily basis and in all three situations the District Attorney (DA) refused to handle the cases due to the store owner’s lack of internal controls. The Federal Government is not responsible to mandate proper internal controls at a private level since shareholders do not exist; only to enforce payment if they are not properly made. The DA rarely takes a case for less than 100k.

Small business owners must monitor their own internal controls to assure fraud is not occurring. Unfortunately a majority of the fraud I have personally analyzed at the small business level is conducted by long term employees, personal friends, or family members. A small business owner should never trust any person to all accounting transactions while operating a company. If a bookkeeper is writing checks (which they should never be allowed to do), then another person needs to be reconciling the books at months end to catch any discrepancies. Although it may be slightly more costly, signing checks, reconciling accounts, and completing month’s end-reports should all be completed by separate entities, unless the small business can accomplish the task themselves. Embezzlement cannot be blames on any party other than the owner of the company…it’s just that simple.

See also  Why Small Companies Fail

------------------------------------------------

BIOGRAPHY

Dr. Melissa Luke is a practitioner in the financial and securities markets, specializing in maintaining positive economic conditions within domestic and international organizations for maximum profitability.

Dr. Luke has directly worked with top agency authorities such as the Securities and Exchange Commission (SEC), the National Association of Securities Dealers (NASD), and the Public Company Accounting Oversight Board (PCAOB) to increase knowledge base for university students and business owners nationwide.

She assists leaders in maintaining corporate vitality and economic growth within an organizations strategic structure and shareholder realm.

Melissa was a professional guest speaker, conducting seminars nationwide and in Canada on market makers, electronic control networks, arbitrage, Level II systems, technical approaches, and crisis prevention methods for corporate securities and welfare, and the Sarbanes-Oxley Act of 2002.

She has published securities educational methods for global distribution, and has worked with several foreign governments on securities issues.

Dr. Luke beta tested the primary software systems used for many of the major brokerage houses and online trading entities prior to the inception and implementation to the general public. She also trains all levels of organizations and corporations on the identification process of corporate malfeasance and fraudulent activity, to protect the corporate executives and public shareholders.

She educates 21st Century organizations, investigates wrongdoing, conducts extensive research on the intricacies of the Sarbanes-Oxley Act, and recruits knowledgeable professionals on the requirements of compliance of corporate fraud utilizing her prior experience working for the United States Treasury.

Currently, Dr. Luke analyzes corporate legal entities, methods of operation, systems, internal controls, employee management, ownership, and corporate structure to maximize profitability and provide recommendations to improve ease of operation, productivity, and profitability of small to medium sized business in the United States.

She also teaches undergraduates at Boise State University as an adjunct professor in management and doctoral students at North Central University in finance.

Comments: