Wednesday, May 13, 2009

Locks Keep Honest People Honest

I believe most people are honest.  Yet with the right amount of opportunity, even the best are tempted to steal from their employer.  This is why every business, regardless of its size, needs to have some internal controls in place to protect the company and the its honest employees.

The examples of employee theft and embezzlement are far too many to cite.  But most of us have heard at least one horror story.  I met the owner of a company yesterday who had an employee embezzle over $1,000,000 from the company.  And this employee was an upright member of the community known for being honest.  So how did this happen?

It starts with a company that gives more and more control in the accounting and finance functions of the firm to just one person.  Phrases like: "I would trust him with my life," and "I know I can trust him - he is honest and loyal to me," become the basis for giving more and more control.  The challenge is that the more control someone has, the greater the temptation becomes to steal because no one is looking and no one will notice.

As the temptation grows for the employee, he or she begins to have more of an entitlement mentality towards the employer.  Thoughts like: "I deserve to take this from the company because I've been working overtime for six months with no extra pay or bonus."  I was once part of terminating an employee who had stolen fuel from our company.  His response was that he had worked some overtime and, instead of putting it on his time sheet he thought he would just make up for it by taking a little fuel.  Again, entitlement begins to creep in.

Once the employee gets away with a little theft, it can become addicting.  They become so entrenched in the lies they are living they begin to distance themselves from reality with overwhelming justifications for their behavior.

So, how does a small to medium-sized business owner avoid this problem?  First, please know that there are many people who are dis-honest and will try to steal from you no matter what controls you put in place.  With that as a disclaimer, you should consider some of these suggestions as low-cost alternatives to trusting just one person with all of the controls:

  1. Consider separating the activities of creating invoices, receiving payments, applying payments, opening bank statements, and reconciling bank statements between at least two people.  Even if you need to have someone work a couple of hours a month on a couple of these functions, it could be well worth it
  2. Regularly audit your customer and vendor list to validate they are real
  3. Regularly audit payroll by verifying the existence and value added by all employees
  4. If you or your employees handle cash, put systems in place to hold those employees accountable for every penny they touch.

These are just a few suggestions, and there are many more.  By establishing the right controls in your business in a cost-effective manner, you will be taking steps that will help protect you, your company, and your employees.

One additional thought - I recently met a business owner who installed security cameras in his business in very visible locations.  He never hooked them up, and the cameras never actually recorded any video.  But the theft of time and inventory by his employees dropped to almost nothing.  With the cameras acting as "big brother," the employees were incentivized to remain honest.

Friday, May 8, 2009

Cash Does Not Equal Profit

Profit and cash are not synonymous, although many entrepreneurs, founders, business owners, and CEOs do not understand why.

The reason lies in the very format of the statement of cash flow. Cash flow is derived by taking NET INCOME for the period and adjusting it for the various non-cash and balance sheet account changes during the period. It is very uncommon that, once going through that calculation, the net income and cash flow will be the same in the same period. And if they are equal, it is almost always a matter of chance that have to do with working capital, capital expenditures, and financing activities during the period.

Why should we care? A company who runs their business purely on cash flow will make bad decisions. A company who runs their business only on net income will also make bad decisions. With both (and an accurate balance sheet), we have the tools to improve profitability and maximize cash flow. Do your competitors run their business in this way? You either need to level the playing field, or make this one component of your overall competitive advantage.