Contents
Introduction 3
Summary 15
Case studies 16
Internal Controls for Small Business
Introduction
This guide will help small business owners look critically Small businesses are known for having weak internal
at their business and examine whether their procedures controls and this guide aims to focus owners' attention on
adequately minimise risks and promote best practice what to look for when reviewing the business.
within the firm. A small business has limited resources,
Owners/managers hold the key to the fight against
and the owner you, must be active and vigilant to
internal control failures and must be attentive to
protect those resources. Good internal controls help you
the concept and issues of internal controls to maximise
manage resources and make sure operations are efficient
the business potential and minimise the risk of fraud, error
and effective.
and loss.
It may seem harsh but it has been stated that, when it
comes to small business, all fraud starts with the owner. It
happens if you have been too trustful or too distracted
either chasing more business or enjoying success.
Compared to large businesses, you have fewer staff to
check the effectiveness of procedures and systems in your
business and usually there are no auditors to do internal
controls checks for you.
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Internal Controls for Small Business
4
Internal Controls for Small Business
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Internal Controls for Small Business
These controls aim to protect physical and • Number documents such as cheques sequentially
non-physical assets and minimise losses from both to avoid duplication
internal and external events. Physical assets include cash, • Regular reconciliation of accounts
stock and equipment while non-physical assets could
include debtors, intellectual property or customer lists. • Automated controls such as valid date ranges or dollar
Types of control techniques used value limits
to protect assets include: • Comparisons between budgeted and actual figures
• Making sure there is an independent check Very small businesses may question the need for internal
on processes and procedures controls, or consider they are only useful in larger
businesses, however many controls can be modified for
• Having firewalls and protective devises small businesses. Even sole operators can regularly
on computer systems reconcile bank statements and cheque books or check
• Having clear guidelines on personal use of assets budgets against actuals. Personal observation and routine
checks can detect errors before they have an effect in
• Ensuring proper management supervision. another part of the business.
• All assets and liabilities actually exist • Physical controls to prevent accidents
• The records cover the whole story and are complete • Processing customer complaints
• All liabilities, rights and obligations are included • Staff feedback processes
• All entries have been allocated to the correct accounts • Procedures well documented
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Internal Controls for Small Business
• Validation checks
check amounts on invoices signed off
• Segregation of duties
receipting separate from banking cash
• Exception routines
spot checks
• Physical controls
limited access to equipment, petty cash
• Rotation of duties
petty cash, receipting
• Assignment of responsibility
clear lines of responsibility
Depending on the importance of a control,
• Management supervision,
a business may use a number of control processes in
monitoring & review
combination. For example, if the business had a large
regular checks, review of personnel
cash take every day, it might combine segregation of
duties combined with physical controls on access • Employee knowledge & skills
to the cash. staff must be fully trained in their job
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Internal Controls for Small Business
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Internal Controls for Small Business
Purchases and accounts payable • Check vendor address that match employee addresses
Many small businesses have found mistakes made in their • Look out for large billings broken into multiple smaller
purchasing and accounts payable can be very costly to invoices each of which is for an amount that would
the business. This is an area that deserves careful not attract attention
attention. There should be many internal controls within • Once a month select a type of vendor (such as all
the billing and invoice payments. Make sure that you tradespersons) and review each line total and number
have a clear and simple list of written procedures for of invoices for each vendor
purchases and accounts payable to ensure all staff know
• Check out the competitors' prices if you rely heavily on
the process they are expected to follow.
one supplier
Some important but simple checks to consider when
• Investigate invoices for poorly defined services
reviewing payments are:
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Internal Controls for Small Business
Non current assets • Maintain complete payroll records for holiday and
Physical assets are as easy to misplace and lose, if sick leave
not kept secure. Assets can be taken from within • Use direct deposits for pays although not foolproof,
the business by the staff or from external visitors to the this can cut down on payroll chicanery by eliminating
business or from someone passing off the street. Consider paper paycheques and the possibility of alteration,
all possibilities when setting up your environment. forgery and most theft;
• Laptop computers and data projectors are popular • Ensure that more than one person can
targets for theft so lock them to a desk process the payroll
• If your office entrance is located near the street or a Find out more about your employees
staircase ensure hand bags and petty cash are well In a small business you are very reliant on your
locked up at all times employees. They are your representatives with customers,
• Once any asset is purchased it should be recorded on suppliers and competitors. Take the time to hire the right
an asset register with all relevant details (this helps person for the job and your style of management, as the
with the accounting as well) costs of hiring and training is equivalent to three months
• Allocate a staff member to be responsible for any wages. This is not an easy process.
expensive items, ensure staff know the location of the Unfortunately some people do falsify their employment
asset and lock it away when not in use records to get a good job – it is more common than
• Review your physical assets regularly against your asset you think.
register and investigate any missing items. Make sure
• When taking on a new employee, always take the
this is done irregularly not just on 30 June
time to check out their employment record, ring the
• Ensure the same person is not responsible for ordering, referees and don't just rely on written references
recording and paying for purchases
• Check out any education credentials that are essential
• If you run a retail business with a high shrinkage make to the operation of the business
sure your staff discount is high enough to ensure staff
• Undertake performance reviews with staff
purchase your goods and do not just take them
• Ensure adequate training is provided
Payroll
• Clearly outline responsibilities and expectations
Many payrolls, even small ones, are now automated, so
it is easier to commit fraud or make mistakes if the • Keep lines of communication open with employees
internal controls are not tight and procedures are not • Employee resentment increases, when the owner
set or followed. enjoys success without passing it on to employees
• If an electronic payroll is used ensure supervisors • Be sensitive of employees hopes and expectations
change their password often
• Don't misplace trust – one person in a small business
• Ensure passwords are not handed to other staff
usually bears an inordinate amount of financial
members when the person is on holiday or sick
responsibility. Review your office staff.
• Ensure any payroll summaries are in the same type
face as the systems printer to avoid possible fraud
Staff feedback
• Review bank account deposits to ensure that each pay Finally develop a process for staff to report breaches in
goes to a different bank account internal controls and report suspicious behaviour. Ensure
• Where possible, segregate payroll preparation, that staff know your door is always open and concerns
disbursement and distribution functions are welcome, not a nuisance. Most fraud is detected by
staff tipping off the auditors, owners or accountants.
• Beware of budget variations in payroll expense and
Reward staff for innovative ideas, perhaps a gift voucher
investigate
for every useable suggestion.
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Internal Controls for Small Business
Example A
A data entry person input the date (15 February 2000) ACTION
into the amount field of an account by error when How would you pick this up in your business?
entering a receipt resulting in an amount of What internal control systems would help this
$1.522 million. problem?
ACTION
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Internal Controls for Small Business
Collusion
This usually occurs when two or more people come
together in an attempt to defraud. Collusion is hard to
defeat in a small business. In this case the owner's
presence and fear of being caught are deterrents.
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Internal Controls for Small Business
ACTION
Fraud
Millions of dollars are lost every day in all business Can you think of examples of ineffective controls
environments due to fraud. Fraud can be committed by within your business?
an individual, a number of staff and/or external parties.
But fraud doesn't happen in a vacuum, fraud occurs due
to a perception that it is possible to avoid being caught. When internal controls are breached, changing personnel
is a waste of time if:
Bad decisions for the business
• defective internal control policies remain the same;
Not reconciling bank accounts regularly may result in over
• management shies away from its responsibilities;
spending, and sudden cash shortfalls which can even lead
to bankruptcy or insolvency. • tough decisions are pushed further out into the future.
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Internal Controls for Small Business
Error reduction
Good and clear internal controls procedures minimise
errors and save time and money. It helps ensure business
information is correct and that staff are accountable for
their actions. For example, staff should know how to
check their own work to ensure it is accurate.
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Internal Controls for Small Business
Summary
Internal controls
• Are needed to promote the efficient use of assets;
• Encompass the total business culture, structure
and methods;
• Encourage positive behaviour;
• Protect staff and resources;
• Help promote the efficient use of the
business's resources
• Communicate and educate
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Internal Controls for Small Business
Case Studies
Pam’s parable Payment twice
After graduating from high school, Pam got a job at a car How often do you overpay a supplier or pay an
wash station in the parking lot at a small mall. After two invoice twice?
weeks of sitting alone in her small booth it occurred to
Office Supplies Pty. Ltd is a fast growing new business.
Pam that no one was watching her. Since she was a little
The owner Bob signs all cheques and keeps a tight reign
short of money she took $10. The next day she took $20.
on all parts of the business. He believes nothing could get
Several weeks went by and Pam continued to filch small
past him!
amounts of money.
Anita is the accounts payable person, receptionist and
Then one day the firm's part-time accountant showed up
office manager all rolled into one. There are also several
at the booth unannounced. By counting her cash, the
sales staff, but they are usually on the road doing
accountant quickly found Pam had stolen more that
the deals.
$500. When he confronted her, she confessed she had
borrowed the money without authorisation. The One week a number of suppliers started ringing up
accountant asked whether Pam knew someone would wanting their money as their accounts were overdue and
check her work. "No" she replied "until you walked in Bob told Anita to stall them, as there wasn't enough cash
here I didn't even know what an audit was.” in the bank.
This case highlights two important concepts. Pam really After another week went by and three important
didn't have an opportunity to commit and conceal her suppliers were getting insistent so Anita tried to get their
theft, she only thought she did ñ because the owners invoices processed and give them to Bob to sign. But she
didn't tell her they were planning to conduct a surprise could not find them anywhere. So she asked them to fax
audit. So managers must point out to staff the controls in another copy. They faxed in statements of outstanding.
and the risks of fraud. This will also deter people who Bob finally agreed to sign them as some cash had arrived
have the opportunity to commit fraud. in the bank account. Then at the end of the following
week Bob turned up with a file of invoices that he had
been sitting on. Anita madly processed then to get them
out by the end of the month.
And if they did, did reliable Anita bank the cheques into
the business's bank amount or did she get them
endorsed over to her account?
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