Preventing fraud in a family business

A recent survey revealed that the leading cause of fraud in businesses is a lack of good internal controls. Because family businesses often operate less formally than many closely held businesses, detecting and preventing fraud may be of special concern to you.

Ethics policy

One way to start is with a policy statement stressing the importance of honesty and ethical behavior. Distribute it to employees and ask them to sign acknowledging they read the statement. A copy should be posted on your company bulletin board. Employees need to understand that violating this policy is serious and those found guilty will be dealt with severely.

Hire good people

If possible, do background checks. The greatest indicator of an employee's future potential is his or her past performance. Get as much information as legally possible.

Bonding

Where appropriate, bond people who are in a position to defraud the company.

Checks and balances

Do not let any one person control a critical function. Make sure that at least two people know the job. Split tasks where possible. For example, have one person open the mail and another record receipts, and still another make the bank deposits. You can deter fraud if a person knows that someone else oversees his work.

Require employees to take vacations, and be sure that other employees take over during their absences. Be leery of employees who jealously guard their turf to the exclusion of others.

Written job descriptions

Written job descriptions help to delineate job duties. This can ensure that potential wrongdoers are prevented from stepping into areas where they do not belong.

Internal controls

Situations may arise in which good people commit fraud because they are tempted. Because anyone can be tempted, a good internal control system can protect your business.

Internal controls starts with involvement by the family business owner. Monthly bank statements should be delivered unopened to the owner. The owner should peruse the checks to make sure they all have authorized signatures and look reasonable, both to the amount and the payee.

Periodically, a receipts listing created by a person opening mail should be compared with bank deposits. In addition, all payments should be made by check and should be checked against paid invoices.

Supervisors should sign for all materials and produce weekly materials reports. They should also conduct periodic field inspections and be held accountable for any discrepancies. Only the family business owner should approve large requisitions and change orders.

Payables should be reviewed periodically by checking the details of each invoice. Overtime requests should be monitored. Tools and supplies should be inventoried and, where appropriate, a sign-out procedure implemented.

A financial statement audit can uncover problems with internal controls. As part of any audit of your company financial statement, your accounting firm will review your internal controls to determine how much reliance they can have on internally prepared financial information. This review will typically find weak areas that could lead to fraud, along with suggestions to fix them. Compliance has the added benefit of reducing your accounting fees in many cases.

Telltale signs

If you know what to look for, you may spot fraud while it is occurring. You may see:

-- Changes in the lifestyle, spending habits or behavior of one or more employees.

-- Frequent complaints from customers.

-- Missing files.

-- Internal controls being overridden.

-- Excessive purchases or expenses.

If you detect fraud, a forensic accountant can review your records to uncover evidence. You may also want to call your attorney, who can advise you on how to proceed legally. Failure to prosecute could send the wrong message to employees.

Who commits fraud?

The most likely employee to commit a fraud is one who is dissatisfied. The best way to combat this is to keep employees satisfied. Do everything you can to promote job satisfaction, which includes providing a good work environment, getting personally involved with your employees, encouraging innovation and giving all employees the potential for promotion.

Good pay is also a motivator, but not as strong as many employers think. Surveys have shown that the majority of employees place greater importance on liking their work and receiving positive feedback than on receiving high pay.

Melvin J. Van de Ven, CPA, CVA, is a partner in the certified public accounting firm of Schott & Van de Ven in Cape Girardeau. (email at mvandeven@schottvandeven.com)