Internal Control for Small Business
...ore detail when effective controls are discussed. It is important to write down control procedures because those written procedures can help train new staff in the correct proceedings of the business (Campbell 4). This should provide a good description of what internal controls are and how they are setup. Why do small businesses need internal controls? As stated in the beginning, business scandals are not just limited to larger businesses; small businesses can also be targeted. Internal controls are in place to prevent those scandals from occurring or if they do to make it easier to trace. There are many dangers in having none or weak internal controls and one of those dangers is theft. Here is an important statistic on the dangers of theft, “According to one estimate, for example, almost one-third of all business failures in the United States are due to internal theft” (Snyder 48). This can be deadly to small businesses because they generally have smaller cash flows and any theft would be difficult to deal with. Another danger facing small business is fraud. “Internal fraud can be generally defined as use of one’s occupation for personal financial gain through deliberate misuse or misapplication of the business resources and assets and is a three step process: The Act, Concealment, and Conversion. To successfully commit fraud, the offender must complete all three steps” (Johnson 57). Fraud is also called white collar crime due to it being perpetuated mainly by staff positions who usually wear white collared shirts. This danger seems to be most prevalent in larger businesses, but it occurs in smaller businesses also. In fact, “Small businesses are at greater risk of fraud because they do not have the resources that larger corporations have install sophisticated security devices and elaborate audit and security procedures” (Johnson 58). The two dangers, theft and fraud, are part of a bigger danger that will be considered which is “asset misappropriation” (Wells). This not only encompasses theft and fraud, but also those “…who wrongly use company equipment (for example, computers and software) for his or her own personal benefit…” (Wells). If an employee is using company equipment for their own self, then that is the same as theft. The employee is stealing the time with the equipment, or the production from the equipment. Asset misappropriation can become a problem in business so it is important to have internal controls setup to prevent these misappropriations. Now that the consequences of poor internal control have been presented it is time to present effective internal controls that small businesses can use. Before presenting some internal controls for small businesses it is essential that one knows why there is a difference between internal controls for small and large businesses. Small businesses face some special problems that large businesses do not. Those special problems are: Management personnel with limited financial experience and accounting personnel with limited financial and accounting capabilities. Little segregation of functions because of the small number of employees. Informally designed procedures. Easy access by clerical and administrative personnel to physical assets. Informal systems of reporting, analysis, planning and control, which are dependent on the management style of the executives. (Grollman 64-65). Due to these problems smaller businesses cannot have the internal control systems of larger businesses, but they can still have effective internal controls. One such way for small businesses to have effective internal control is through executive control. The idea behind executive control is that the executive has an active interest in the business and especially in smaller businesses where the executives are involved deeply in the daily operations. Just through observations of employee’s actions and the daily routine of the business the executive is in a good position to ensure no wrong doing by employees. “Another key element of executive control is the approval of transactions” (Grollman 66). It would be incredibly hard for an executive to approve all transactions, so it would be up to the executive to determine what transactions would need his or her approval. This could reduce theft involving high amounts. Along with transaction approval the executive could require operating reports be submitted in a timely fashion. By making the reports due in a timely manner it would lower the time that a person could cover up any misappropriations that might have occurred. Also by checking the reports and running certain ratios the executive could check to make sure that the ratios are not fluctuating wildly from month to month. If there are fluctuations the executive could demand explanations for these fluctuations, which would provide a check against employees trying to cover up. Executive control is just one way to strengthen internal control. As mentioned earlier, control procedures are in place to ensure that employees take corrective action. In fact, control procedures are probably the most important part of strong internal controls. Control procedures ensure that duties are performed in certain ways, and if not then one should look into why those procedures were not followed and what the consequences were. There are four objectives that control procedures should accomplish: “Safeguarding the assets, checking the accuracy and reliability of the accounting data, promotion of operational efficiency, and encouragement of adherence to prescribed managerial policies” (Zlatkovich 421). Let us examine each of the four objectives and identifiy ways to accomplish each of those objectives. First is that primary objective of “safeguarding the assets” which means ensuring that all assets including cash and inventory are at the right amounts. One way to accomplish this is to secure assets with locks or storing them in another premise (Snyder 51). This would eliminate assets from being accessed by everyone. A written control procedure for this could establish who would have access to the assets and set up a protocol for gaining access to the assets. All assets could be locked up, but it is mainly used for physical assets such as inventory. When dealing with cash, which is the main asset that is misappropriated the most, there needs to be other procedures setup to ensure proper internal controls. Some examples include: “Allow only specific designated individuals to handle cash, use numbered receipts to document all payments, make all bank deposits promptly, make deposits intact with no amounts withdrawn to pay expenses, make certain every payment is related to a paper document, such as a voucher, to ensure that a paper trail exists for all disbursements…” (Day). Those are great control procedures to ensure that cash is not misappropriated. The second objective is, “checking the accuracy and reliability of the accounting data”. To accomplish this objective one must ensure that, “All assets and liabilities actually exist, the records cover the whole story and are complete, all liabilities, rights and obligations are included, all entries have been allocated to the correct accounts, all relevant information has been disclosed” (Campbell 6). Some control procedures that could be used are: numbered documents, regular account reconci...