The Sophomore Slump

Improving Internal Controls in Small Companies Once They Succeed

 


The real difficulty that anti-fraud professionals face in small businesses once they succeed isn't designing or implementing financial controls but convincing owners to make the necessary investments and give up sufficient authority to allow the controls to work.

Western Slope Contractors Inc. (WSCI) had just entered its tenth year of operation. The company had recently opened two new stores and gross sales had just topped $7 million. The only problem was that the company was broke. Despite record-breaking sales, there was essentially no money in the company. An unscrupulous bookkeeper with too much responsibility had simply stolen it all. The scams were simple: multiple or inflated salary checks, paying for personal expenses with company funds, and the theft of inventory to help build her new home. Moreover, the signs of fraud were there for anyone to see. She drove an expensive new pickup, had an extensive wardrobe, and had recently undergone cosmetic surgery which wasn't covered by her medical plan. How did she manage this in a business that had successfully survived its early years and was flourishing? The answer, ironically, is that the business was a victim of its own success. It had simply outgrown its control mechanisms.1

How good businesses can go bad

The case of WSCI is not unique in the world of fraud prevention, nor, unfortunately is it even uncommon. What happened with WSCI is the combination of two separate but related problems: a company which had grown too large for its internal controls and an owner who was unwilling to delegate sufficient authority to institute better controls. The real difficulty that anti-fraud professionals face in small businesses isn't designing or implementing financial controls but convincing owners to make the necessary investment and give up sufficient authority to allow the controls to work.

Roughly two thirds of all small businesses fail within five years of their inceptions. (Dennis, 1999) A less obvious consequence of this statistic is that most entrepreneurs don't follow managerial steps necessary to keep their businesses running once they've become successful and turn a profit. As a result, small businesses can become too unwieldy to manage and often fail just at the point when they seem poised to take off. In the case of WSCI, the owner had spread himself too thin. Where he once personally approved every purchase order and payment check, his hectic schedule and hands-on management style now kept him on the road five days every week. When his bookkeeper offered to take up the slack, it seemed like a gift from heaven. Unfortunately, the same owner oversight no longer applied and the bookkeeper was able to take advantage of this weakness to loot the company.
 

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