How to Protect Your Wood Flooring Business By Implementing Internal Financial Controls

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Moneymag3 Internal financial controls are essential to your business: They help prevent and detect fraud. Implementing them starts with the company leader and filters down through your entire organization. Done right, they can achieve reasonable (although not absolute) assurance that the objectives of your business are met. With good internal controls, you can also generate reliable financial reporting while complying with laws and regulations.

Some "fraud" is actually the result of innocent employee error, like when an accounts payable clerk forgets to compare the price on an invoice to the price on a purchase order, resulting in the company paying more than it should have to pay. Or, when a supplier's shipment is received without the proper purchasing documentation, resulting in the company paying for something it doesn't even need. Here, proper oversight or direction could have avoided the problem, but what about instances when employees are deliberately trying to steal from the company?

Types of Fraud

Asset losses that occur through deliberate fraud by an employee (or employees) are usually covered up, making them more difficult to detect. Here is an overview of fraud types so that you can attempt to stop them before they happen:

Expense Account Abuse. Employees can use fake expense receipts, request reimbursement of unapproved items, or include the same item multiple times on their expense reports. You should have a policy in place that requires receipts and approvals for each expense report.

Financial Reporting Misrepresentation. Even though no assets are actually stolen, falsification of a financial statement is still fraud since it projects an altered image of your company to outside parties.

Fixed Asset Theft. As the name implies, fixed assets are usually large enough to be immovable, but many items such as computers and tools can be stolen by employees. Most companies do not want to safeguard fixed assets through the use of security guard services; however, these assets can be protected by simply carrying insurance with a minimum deductible.

Inventory and Supply Theft. One of the easiest types of theft involves employees taking inventory or supplies from the storage shelf and walking away with them. Inventory controls can be improved through the use of fencing or limiting access to the warehouse. The extent to which controls are applied here depends on the amount of pilferage and the value of inventory and supplies.


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Purchases for Personal Use. Employees may use company credit cards for the purchase of items that can be diverted for personal use. A detailed record of all credit card purchases should be required, rather than relying on spot checks or the incoming credit card statement.

Supplier Kickbacks. Purchasers can make arrangements with suppliers to buy from them in exchange for kickback payments. This type of fraud usually results in higher prices being paid to suppliers. Fraud of this nature is hard to detect because it requires the constant review of prices paid as compared to market rates.

This covers just some types of fraud-it is by no means all-inclusive. Fraud problems may increase in some organizations because the business environment makes it easier for fraud to occur. For example, increased emphasis on higher profits could lead to false financial reporting. Fraud is more likely if there are unrealistic growth objectives, problems within management ranks, or if controls are not keeping pace with organizational growth.

Internal Controls

Now that we've established some of the more common ways a company may be defrauded, we'll look at some common internal controls to stop it.

Cash. Cash is one of the most important assets in a company and is critical to its operation. The following are some of the more common controls.

  • Comparing the check register to the actual check number sequence.
  • Conducting spot audits of petty cash, keeping in mind that it's possible to falsify petty cash records through the use of miscellaneous receipts and IOUs.
  • Controlling the check stock, making sure that checks are kept under lock and key.
  • Controlling signature plates, which should be stored in a secure area.
  • Depositing checks daily.
  • Filling in empty spaces on checks. If the amount line of a check is left partially blank, an additional amount may be inserted.
  • Limiting petty cash reserves.
  • Mutilating voided checks. Be sure to stamp voided checks "Void," or tear off the signature line to avoid cashing of the check.
  • Performing bank reconciliations monthly. This should be done by someone who has no association with accounts payable, accounts receivable or cash receipts.
  • Reviewing un-cashed checks. It is possible that an un-cashed check is created through a flaw in the system, which could send a check to a nonexistent supplier.
  • Stamping incoming checks "For Deposit Only."

Accounts Receivable. Controls are needed here to stop employees from taking customer payments and hiding them by altering customer records. The most common controls for this area are:

    • Confirming accounts receivable balances. If an employee happens to be hiding deposits, then it is possible to detect this loss through periodically sending an account confirmation to the customer.
    • Requiring approval of credits. Pilferage may occur through an employee's granting credit to a customer in exchange for a kickback. This can be prevented through the use of forms for the granting of all credits.

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  • Comparing checks received to money posted against accounts receivable. A clerk could cash a customer check and deposit it into his or her own account. Subsequently, they could keep applying funds received to the oldest invoice, thus disguising the fraud. Periodic comparisons of checks on deposit slips against accounts charged can help fight this type of fraud.

Inventory. Tracking inventory can be extremely complex, lending to the need for good internal controls. Common controls include:

  • Requiring transaction forms for scrap and rework transactions. In a manufacturing operation, there is a starting amount of materials and direct labor that can be lost through scrap. This is a difficult area to control since scrap materials and reworks occur at many points of an operation. Staff should be well trained in the use of transaction forms that record this process so that inventory records remain accurate.
  • Conducting inventory audits. Due to error, inventory tends to gradually differ from what is in your books. Do a full inventory twice a year, or cycle through the entire inventory over the course of a year.
  • Investigating negative-balance perpetual records. If a balance in the perpetual records ever reaches a negative balance, always investigate it to determine the cause and make sure it does not happen again.
  • Reviewing inventory for obsolete items. This area tends to be the largest cause of inventory valuation errors. One way to avoid this is to print a report that lists inventory items that have not been used recently, including the extended cost. An alternative method is to create a report that compares on-hand inventory to an item's historical usage.

Accounts Payable. This is the most common area of company fraud and transactional errors. But first, a word of caution: This area requires a combination of controls, and it's important they are applied judiciously. They include: 

  • Auditing credit card statements. To avoid having company credit cards used on non-business purchases, credit cards should be audited regularly. Apply limitations on the amount that can be charged to keep an employee within spending limits.
  • Verifying authorizations with a three-way match of the purchase order, invoice, and receiving report. This matches the invoice with purchase order pricing and the quantity charged against the quantity received. This ability is included in certain computer programs.
  • Independently reviewing additions to the vendor file. Have someone not associated with accounts payable review all additions to the master vendor file to avoid payments to fictitious vendors.
  • Requiring approval on all invoices that do not have a purchase order. If a purchase order has not been issued, then the invoice should be sent to the supervisor of the department being charged for approval.

Focusing on the above areas is a good starting point; however, this is just a portion of the necessary controls. Other areas include investments, employee advances, fixed assets, notes payable, revenues, and travel and entertainment. By keeping these controls in mind, you'll be in a better position to truly evaluate your bottom line and run a better, more profitable business. 


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