Internal Controls

Author: Larry Chester

Many entrepreneurs have one person they trust implicitly with their business operations, finances, and administrative activities. But the real question is: Should they?

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Often, the first person an entrepreneur hires when starting a business is an administrative professional. This person learns all the ins and outs of the accounting system and everything else about the business. They become more than just a capable employee, the entire day-to-day operation rests with them. Unfortunately, that can mean unnecessary risks that can either be easily resolved, or ignored at great cost.

• Business – Call center
• Location – Suburban Chicago
• Sales – $17,000,000
• Ownership – Single owner LLC

Initial Contact –

The office manager was integral to the business, and the owner was interested in finding someone to backstop her. Also, although the company was profitable, it wasn’t building any cash balances.

Significant Findings and Recommendations:

Internal Controls – Cash Operations

The office manager controlled the company’s financial operations. She did payroll, accounts payable, invoicing and cash receipts. She rarely took time off, and even then, came back when they needed to run checks or payroll. The owner viewed her as key to running the business.

Recommendations

• Segregation of duties is critical so that everything isn’t done by one person. Having one person do everything can lead to fraud and theft. Oversight can help, but segregation of duties is the best alternative.
• Take the three primary cash responsibilities—accounts payable, accounts receivable, and payroll—and cross train others so that they can take over if needed.
• Provide close oversight of cash operations:
• New vendors should be approved by management.
• Checks should only be signed by senior management.
• Bank reconciliations should be reviewed by management. In addition, each payment that clears the bank should be verified.
• Any direct payments (ACH or wires) should be signed off on by management. Credit card bills should also be reviewed.
• The payroll register should be reviewed by management following every payroll.
• The cash receipts journal should match bank deposits. Any credit memos should be approved by management.

Cash Management

Although the company was profitable, the owner wasn’t able to take as much money out of the business as he wanted. He didn’t understand where the cash was going.

Recommendation

• Develop a cash flow forecast, identifying cash to be received and cash expenditures each week.
• Match the forecast to actuals on a weekly basis. Any variances need to be identified and understood.
• Pay the owner a pre-determined amount of cash as a regular draw, whenever the employees get paid.
• Analyze last year’s cash payments to identify where the company’s money was spent.

Financial Reporting

He proudly gave me a monthly report, to show how much information he was getting. That report—the Income Statement—was over 90 pages long! It provided significant detail in every account. But the owner wasn’t able to get a handle on the overall performance of the company. He was drowning in granular data.

Recommendations

• Create a summarized Income Statement and Balance Sheet so they each fit on one or two sheets of paper. Eliminate the extreme amount of detail so that management can see at a glance the overall operations of the company.
• Create a list of critical KPIs with monthly tracking, so that management can review the progress of the company in reaching goals that are meaningful for everyone.
• Develop a series of subsidiary reports that provide worthwhile detail on each critical aspect of company operations. Focusing on those important numbers will improve critical decision-making to operate the business.

It’s not unusual for a business owner to have total faith in the employees that have been with them for a long time—or handle important administrative and financial functions. But time and time again, a lack of internal controls provides an avenue for honest people to find little ways to “share” the company’s wealth. Soon the numbers become larger, and there’s no going back. Proper internal controls keep honest people honest, and make sure your business hangs on to its profits. When an employee is so devoted to the company that they won’t take a vacation, that should be a warning sign to management.

Financial reporting should be clear enough to allow understanding of trends and identification of improvements that are needed. If not, then the month-end package needs to change so that decisions are not made in a vacuum. Visibility is the key to good decision-making.