This is the last of four articles on lessons for business survival. This series has been a look at four separate issues suffered by businesses that have lead to their insolvency – and where we had a recent file that exhibited that issue.
Over the last three months we have looked at:
- June 2009 “Collect Your Money” – the need for businesses to actually invoice and collect their income. It is one thing to earn income, it is quite another to get that money into the bank account.
- July 2009 “Build it, and they may not necessarily come!” – the need for a business to offer something that people actually will pay for at a price that will earn a profit.
- August 2009 “Indigestion Kills as fast as Starvation” – the need for a successful and growing businesses to properly manage its rate of growth.
This month we look at internal controls. These are not quality, production or system controls. These are business controls that govern who does what within the management of the business.
A majority of our e-updates have some article or information on fraud issues, and commonly occupational fraud. Apart from three of the Worrells’ partners being Certified Fraud Examiners and having an interest in the subject, we occasionally find that a business becomes insolvent due to some fraudulent action by an employee. This article explores that issue.
The fact is that some employees can and do steal from their employer, and in some cases they can do it very easily and hide the theft so that it will never be found. This problem is compounded because many small businesses do not have the capacity to employ the range of people necessary to create an effective separation of duties, nor can they afford to implement a wide range of fraud controls. In some cases, the fraud is only discovered once the business owners look for the reasons why they have become insolvent.
Large businesses are not immune to frauds. The recent reports of a potential $20 million fraud by one Clive Peeters’ payroll employees, and the alleged $17 million theft from Specialty Fashion Group (the company behind the Katies stores) highlight this. But smaller businesses are also victims of fraud. The intimacy of a small business sometimes is an advantage, but sometimes it can also be a disadvantage.
Small businesses generally survive on a lean and mean efficiency, decreasing the number of levels of management and the number of people involved in each task. Most SMEs actively look for a single person that can handle many tasks, often administrative and financial. In profit terms it’s efficient. In control terms it can be a recipe for disaster. This is what happened to SW Pty Ltd.
SW Pty Ltd was a small business and engaged an ‘office manager’ to handle the paperwork, make sure that bills were paid, the records were updated and the banking was done, leaving the directors to ‘do the work’. The directors thought that they were maintaining control by retaining the sole authority to approve all payments. But they had no procedure for checking what was actually done, they just directed and approved what should be done.
The employee took advantage of the reality that, once she had obtained approval to do something, there were no checks over what she actually did. She would collate and verify invoices for payment. She would then get approval from the directors to pay the creditors through the company’s online banking service. She could transfer the money as the directors had given her the passwords – effectively making her a signatory to the account.
In one of her (alleged – the police are still prosecuting her) frauds she would get approval to pay a group of invoices, but she would EFT the funds to her own account and enter the payments in the records as being made to the creditors. A short time later she would get the same invoices approved again and this time make the payment to the creditor. This was possible as the directors trusted this employee and generally approved whatever was requested.
Once discovered, the directors calculated almost $90,000 had been taken through dozens of small transactions. A further $100,000 of approved payments should have been made the ATO for PAYG debts, but that money was also diverted.
The company also made some cash sales, and the office manager had control of the banking process. She only banked and recorded a small percentage of the cash sales and skimmed the balance. Because she maintained the business records, did the banking, reconciled the accounts and produced the management records, no one questioned the banking levels. Lastly the directors also found a ‘friend’ of hers on the payroll – having been paid about $7000 in the previous months.
The directors wound up SW Pty Ltd because it could not pay its PAYG commitments. It had been bled dry.
Many owners of failed businesses have stories about dishonest employees at least partially being the cause of the insolvency – and some of them are probably right. We have a number of files (including the above) where the employees have been prosecuted for occupational frauds and many where the directors suspect fraud, but no evidence has been found. The latest is a recent liquidation, where it is suspected that an employee conducting a Billing Fraud and possibly a factoring fraud that was the major cause of the company’s shortfall.
The lesson this week is that, no matter whether business owners have done everything else right, their business empire can be brought down or severely damaged by a dishonest employee. Business owners not only have to worry about the business model, they have to worry about controlling how their employees work within that model.
We hope that this series of articles has been of interest.