Is Your Business at Risk

By Thomas R. Tartaglia, CPA (Jul, 2010)

It is said that small businesses in America drive the US economy. Businesses with fewer than 500 employees are estimated to contribute over 50% of the private gross domestic product. According to recent estimates by the "Small Business Administration" there are 22.9 million small businesses that employ about 50% of all private sector workers. Small businesses are great businesses. They are innovators; highly skilled and they can change rapidly as times change. As a result of these features, small businesses can be quite profitable. The small business owner(s) often do not have the same capital resources as larger corporations. As such, they can struggle with the balance between profits vs. ideal staffing, planning and internal controls.

One of the most common risk factors in a small business is weak internal controls. Internal control is a process controlled by an organization's structure to protect its resources against waste, fraud, and inefficiency, provide reliable financial data and comply with laws and regulations. Responsibility for internal control rests, to some extent, with virtually every employee within the organization. This single fact is also the weakest link within the structure. Therefore employers should consider hiring employees that have high integrity and ethical values and a commitment to competence. They should also treat their employees well and set a good example themselves.

An area of concern among smaller businesses is the risk of theft loss due to the lack of segregation of duties. Segregation of duties is the concept of having more than one person required to complete a task. It provides two benefits: 1) a deliberate fraud is more difficult because it requires collusion of two or more persons, and 2) it is much more likely that innocent errors will be found. A task can be categorized into four types of functions: authorization, custody, record keeping and reconciliation. 

  • The Authorization function determines whether a particular person is authorized to perform a given activity. Authorization may be determined based on a range of restrictions for example requiring two signatures on a check.
  • Custody (of assets) is the function of immediate control and possession, for reason of care and safe keeping, of assets. For example, the procedure of receiving checks in the mail and making deposits should be separate from recordkeeping and authorization.
  • Record keeping and reconciliation functions should be kept separate from the actual handling of assets. For example, the person who receives checks in the mail and the person responsible for signing checks should not be responsible for reconciling the bank statement.

In a perfect world, an organization would employ enough people to sufficiently cover every function within an organization, yet the reality is that many small businesses cannot afford such a luxury. It is not uncommon for one employee to be responsible for maintaining the entire bookkeeping operation. So how does a small business safeguard their assets and remain competitive within its industry?

  • Job rotation: employees should be cross trained and encouraged to take earned vacation time. An employee who refuses to take vacation has control issues and is unwilling to share their duties is one of the warning signs of fraud. In fact, one of the typical reactions of management when informed that an employee committed fraud is "I can't believe it, he / she is one of my most loyal, dedicated employees."
  • Management oversight: owners and managers need to stay involved with the day to day operations. Thumb through checks; be the first one to open and review monthly bank statements and occasionally fill in for your bookkeeper. Monthly reports should be generated that tie all financial activity together for that time period. These reports will show you how the company is performing month to month and may reveal financial errors.
  • Involve a third party such as your CPA. Use your CPA as a "partner" in your business, allowing him or her to analyze your situation and establish accounting controls that work for you.
  • Hire additional staff: If you have been considering hiring new employees, now may be the right time. The President recently signed into law the "Hire Act". Under the Hire Act "qualified" employees (there are specific guidelines as to what constitutes a "qualified" employee) hired after February 3, 2010 and before January 1, 2011 will be exempt from the employers' portion of Social Security Tax. In effect the employers save their portion (6.2%) of the Social Security tax liability. Additionally if the new hire remains an employee for at least 52 consecutive weeks the employer is eligible for an additional tax credit.

The bottom line is to keep your business profitable and as risk free as possible while allowing you to "live well". Addressing these issues in a systematic manner can help your business achieve this balance. The tax professionals at Dermody, Burke and Brown are ready to assist you in achieving your goals.

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