Red Flags of Fraud

In today’s day and age, fraud is occurring all around us. The impact fraud has on your business can be devastating. In fact, The Association of Certified Fraud Examiners’ Global Fraud Study found the typical organization loses a median of 5% of revenue each year due to fraud. Small businesses have it even worse. The same study found companies with fewer than 100 employees lose a median of $155,000 each year due to fraud, compared to a median loss of $120,000 for businesses with 100 or more workers.

These statistics are scary, and fraud can undoubtedly wreak havoc on your business if you don’t catch it.

So how do you prevent fraud from happening in your small business? There are five common areas where red flags of fraud may pop up.

  • Common Sense Flags – These flags are usually obvious, but sometimes overlooked. Some of the most common include:
    • Complaints from other employees regarding an employee
    • Unexplained amounts of overtime
    • Employees who have a history of lying
  • Behavioral Flags – These flags may be easy to recognize by the way an employee is behaving. Examples include:
    • Spending too much time at work – the employee rarely takes vacations and/or never misses work
    • The employee won’t let other employees help them with their workload, even if they’re overwhelmed
    • An employee who manages financial records is extremely protective over the records
  • Accounting Flags – The accounting department has many areas where fraud can be committed. After all, this is where the money is. Be on the lookout for some of these red flags:
    • The business is unexplainably unprofitable
    • You’re noticing cash flow issues
    • There are issues with missing and adjusted inventory balances
    • Account balances aren’t reconciling
    • Unexplained adjustment entries on the books
    • Financial statement trends and ratios don’t make much sense
  • Documentation Flags – Keeping up with documents that go in and out of the business can help you catch fraud in your business. Common issues may include:
    • Excessive credit memos
    • Original documents have been messed with (invoices, vendor statements, bank statements), whether it’s electronically or whited out on a hard copy
    • Deposit slips and receipts that are MIA
    • An excessive amount of accounts receivable being written off
  • Internal Control FlagsYour internal controls are where your business operates on the daily. This leaves a large area where fraud can be occurring. Watch out for these issues:
    • Expense reimbursements do not match up with receipts
    • Background checks on key employees are not being performed
    • A single employee has control of the company check book
    • Internal controls are non-existent or inconsistently enforced
    • Company credit cards are easily accessible to everyone (and support for those expenses is not submitted)

 

Fraud can have a devastating impact on your business, and can be extremely hard to recover from. By keeping an eye out for these red flags, as well as other issues that don’t seem quite right, you can help prevent your business from falling victim to fraud.

A version of this blog was first produced by our Forensics team on eidebailly.com.

 

Final_infogaphic_web_Fraud Red Flags

Meet the Team: Matt Stone (@mattdstone)

matt-stoneWhat is my role?

I have the pleasure of rolling out the Possibilities Center to Sioux Falls, SD and the surrounding area. In doing so, I get to meet with a lot of great entrepreneurs and talk with them about their business, ideas they have and the possibilities for their business. My overall role is to help small businesses grow using a holistic approach. This includes teaching them the importance of having good financials, how to use those financials as a valuable management tool and how to look at their business from the outside in, either as an investor or as a client.

Why are numbers important for business?

The old adage “the numbers tell the story” is true. With the numbers contained in your balance sheet and profit & loss statement, I can tell you what happened in your business for a given period of time. The number story does not end with your financial statements. Numbers, called ratios, can help you make important management decisions. Ratios specific to your business can help you determine if you are performing your mission and achieving your vision. Without numbers, your business becomes extremely inefficient. I encourage every business owner to find themselves a numbers geek and embrace them.

Why do I want you to succeed?

I was self-employed for more than 20 years, prior to coming to Eide Bailly. In that time, I experienced losses and wins. I want to share what I have learned in hopes you can leverage my mistakes and successes. You, the small business, are the backbone of the economy in the United States and the town in which you are located. When you succeed, we all succeed.

#ILoveSmallBiz

I love what small business stands for and what it is. Small business is America at its best. Small businesses signify independence, a drive to do better and to be more. I love the fact anyone, regardless of his or her position in life, can take an idea and bring it to life to create a better life for their family. All it takes is a definite primary aim, faith and action!

Common Troublemakers on the Books

By: Ryan Renner, Eide Bailly LLP

A while back, we discussed some ways to know when things go wrong on your books. When something goes wrong, it’s important to understand the root cause in order to hopefully avoid the problem altogether. While there are many pesky problem causers, the basic concepts of these generally apply to a lot of the most common errors.

Here are a couple of the most common troublemakers we see causing problems on the books.

Lack of Consistency

Often times, errors start in areas of the books that are unfamiliar or new to small business accountants (we can help you get familiar with them – just ask). When these processes aren’t completed consistently and accurately, this can lead to issues over the course of the year that, if not caught right away, can cause even bigger issues down the road.

One common example? Those pesky balance sheets. Balance sheets contain a lot of important information that can tell you where your business stands and where it’s going in the future. If you only reconcile them annually, or convert from a cash to accrual basis at the end of the year, you could end up forgetting what you did previously, and you might even be doing it a little differently. The problem? This can often lead to issues with your prior and current year balances being calculated differently, resulting in balances that don’t make sense.

The best way to correct this common issue and prevent it from taking over is to implement a consistent process over the course of the year. Consider setting up monthly or quarterly updates and reviews. This can help you keep information fresh in your mind (as opposed to trying to figure out how to record something in December that happened back in April), and can also help you remember how a process was completed previously. Although this might add time up front, it can help save time in the long run. Whether you spend your time trying to remember what occurred earlier in the year or trying to find an error caused by a change in your processes, your year-end can become much more efficient when you come up with a consistent process, leading to less errors on the books.

If implementing a consistent monthly process sounds confusing, know that you can always check with your accountant or auditor to make sure you’re doing things correctly from the start. They can help you make sure you’re on the right track, and can help make your process a breeze. 

Letting Issues Grow

Another common issue that leads to major problems on the books is letting issues go and deciding you will take care of them later. Once example is sitting back and ignoring small differences in the details, such as in your bank reconciliations. Generally, we see accountants noticing these small errors, spending a little bit of time of them and then letting them go if they can’t figure out what is going on. They usually push them off and just assume they will figure it out next month.

However, by letting them go and pushing them off until next month, these issues will only continue to grow. If allowed to sit and grow for too long, the issues can build up until you find your business with some serious problems. Although it may seem like a small, pesky task at the time, taking care of issues right away can save you time (and help you keep your calm) later in the future.

It’s also important to note that if these seemingly small issues keep popping up every month, even when you took care of them previously, you may have an even larger underlying problem. Don’t be afraid to seek out assistance when it comes to issues in your business – after all, you’ve invested a lot in it, and you want to make sure everything is in tip-top shape!

Entries from Your Accountants

Your accountants are there to help you and your business grow and be successful, and they really know their stuff. A common (and somewhat perplexing) issue we see is companies and organizations not booking entries from their accountants. Rather than taking the year-end tax or audit work information and putting it in the books, companies often ignore it or post it to the wrong period. Rather than waving this off, schedule time to talk to your accountant to make sure you fully understand what they’re telling you, and ask for help posting them to the books (numbers nerds enjoy helping you understand your finances!).

When it comes to your business, it’s likely you will run into a few speed bumps. When you run into these issues, work to identify what caused the problems in the first place. By identifying these issues and taking care of them right away, you protect your business from falling victim to common mistakes that can seriously impact the success of your business.

You Say Accountant, I Say Controller

You say tomato, I say tomāto. You say accountant, I say controller. Unlike tomato and tomāto, the terms accountant, controller, and chief financial officer (CFO) do have significant differences.

We could go into great detail on what makes them different (oh wait, we did). Instead, here’s a basic breakdown of the difference between the three:

  • An accountant is responsible for entering day-to-day transactions and performing basic accounting functions. These could include entering bills and invoices, running payroll, paying sales tax, etc.
  • A controller is responsible for the accuracy of the financial statements, preparing budgets, calculating financial ratios, etc.
  • A CFO is responsible for a forward looking perspective. They are involved in strategic planning and providing improvement recommendations based on the financial ratios provided by the controller.

Each of these positions relies on the other to get the information they need and to make your accounting and financial processes run more smoothly. Each has a distinct purpose and each is important for the financial health of your business.

Now we know what you’re thinking … there are THREE positions. Yep. But that doesn’t mean they’re three people. Technically, one person could perform all three positions. Often times in small businesses, this is exactly what happens.

The first position you will need is an accountant. Do not take this position lightly. One of the greatest needs of business is the need for good financials. Hire someone who has the knowledge and experience to do a good job, like someone who has experience working with your type of business, or has a strong financial background. If you hire the right person with the right experience, they can also serve as your controller. A CFO is needed when you begin to use your financials as a management tool.

Yet at a certain point, you need to begin to think about expanding your financial department and separating the roles. Knowing when to separate depends on your business. Consider who will be looking at your financials and the purpose for those financials.

So what if you’re just not ready for all three positions? Or, what if you are, but financially you’re not ready to hire all three. After all, recent research shows that a CFO can cost over $125,000.

Look into outsourcing it! A trusted business advisor or accounting firm can help you outsource any number of functions, from the day-to-day functions all the way to the CFO level. Not sure how to find the right advisor to help? Here are six questions you can start with.

By outsourcing these positions, you can free your time to work on your business. Plus, you’ll have a trained professional who can help you understand the importance of your finances and why they matter.

Signs of a Financially Healthy Business

We’ve said it before and we’ll say it again: strong finances are important. After all, without good finances, how will you pay your employees, take care of debts and ultimately make a profit? Your business depends on finances to be successful, so making sure they’re healthy should be a top priority.

Here are six signs your business is financially healthy.

  1. Your revenue is growing – This one might seem a little obvious, but it’s important nonetheless. When looking at your financial statements, you want to see a relatively steady increase in your revenue, whether it be weekly, monthly or even yearly. It doesn’t have to be a big increase either – just a small, steady change can show good health. You know what they say, slow and steady wins the race! Not only do you want to see your revenue growing, but it’s also a good sign if your cash balance is showing growth. Cash is necessary for the operations of your business, so a growing balance can help ensure you’re prepared for any surprises that may pop up.
  2. Your expenses aren’t growing – In order to be profitable, you need your revenue to be in excess of your expenses. To do that, you want your revenue to go up, while your expenses remain the same or even decrease (bonus points if your expenses are decreasing – that’s no easy feat!). While expenses may increase with growth, it’s likely your revenue will increase as well. Growth in your expenses is healthy as long as it’s proportionate with your revenue growth.
  3. You’re gaining market share – Whatever you’re doing, it’s working. Whether you’re offering a product or a service, people like it and are likely telling others about you. Because of this, you’re gaining more customers and staking a larger claim in the market. You wouldn’t be able to see this remarkable growth if it wasn’t for your financial health allowing you to make changes and adapt to the ever changing needs of your market.
  4. Your ratios are looking good – There are multiple ratios to pay attention to that can determine if your business is financially healthy. You want your debt ratios, debt-to-asset and debt-to-equity, to be low. These ratios basically tell you how much you owe in comparison to how much your business is worth or how much cash you have available to pay off debt. Ideally you’d want a high profit margin or above average for your industry (not all business are striving for the same profit margin), as it shows your sales are resulting in a high amount of profit. Finally, you want high turnover ratios. A high inventory ratio can signify you’re efficiently and effectively pushing inventory out the door instead of keeping it holed up in the back, while a high asset turnover can signify effective asset management.
  5. You’re retaining the right employees – Your people are at the heart of your business, and they’ve helped your business become what it is today. However, they likely wouldn’t have been able to stay on board if your business was struggling financially. When your business is financially healthy, you’re able to pay your employees (which is pretty important) and can often times provide added perks and bonuses to keep them around. If you need some ideas for keeping employees engaged and coming back for more, check this out!
  6. Your strong cycles support you throughout the year – If your business is in retail, your busy season is likely during the holidays. If you’re a service provider, your busy season depends on what type of work you do. Your business shows strong financial health if the revenue from busy season can carry you through the slow times. How? If this revenue carries you through, you likely have high enough balances in your accounts to support you all year long, rather than waiting for (and desperately needing) busy season. Pro tip: just because you have a healthy balance doesn’t mean you should go spending all the proceeds from busy time – you’ll still want a cushion for emergencies or new expenditures.

It’s no secret understanding your finances and making sure they’re in tip top shape can help your business grow and become what you dreamed for it. Check in on your business and see how your business is doing with these six pointers – we bet you’re doing great!

Tips for Year-End and a Smooth Audit Prep

By: Stephanie Berggren, Eide Bailly LLP

Year-end is always a hectic time. Your company is making sure that all required state and federal filings are done and internal documents are completed. Plus, to make things even crazier, you’re also starting to think about and prepare for your annual audit. Can you say overwhelming?

One question that is fairly common: How early is too early to start on year-end procedures? The answer? There’s no such thing as too early. We are in a world where activity happens every day that will affect your year-end and your audit, so paying attention and staying up to date is important.

So what does year-end preparation look like?

To get started, at a minimum, you should have a review process that documents when purchase orders are created, when bills are paid and when cash/checks are reviewed and deposited. This will help lay a solid foundation you can use to make sure you’re on the right track.

Monthly, you should be doing reconciliations for the following common accounts:

  • Bank accounts – this helps verify that all revenue and expenditure activity is captured in your records on a monthly basis.
  • Accounts receivable – this will help you make sure your customers are paying in a timely manner, and will also help with your collection procedures.
  • Accounts payable – this will help verify that amounts showing due are true payables and to make sure your vendors are getting paid timely. This may also help you take advantage of discounts given by your vendors for early payment.
  • Capital asset inventory – this will help establish that any capital outlays are added to your software and/or external schedule. This list is an audit necessity.
  • Payroll accounts (accruals and expenses) – this will help verify that payroll is being accounted for properly in the correct accounts.

Doing these tasks on a monthly basis establishes good review and control habits. It also gives you, or your accounting and finance team the ability to find and fix errors during the year – and before your auditors find them.

Now that we’ve reviewed what to do on a monthly basis, let’s discuss year-end. Annually, you should:

  • Review checks paid after year-end to make sure they are properly included in or excluded from your accounts payable ledger. This not only helps make sure your auditor isn’t finding any adjusting entries during their audit, but also helps ensure you have included all your expenses in the proper year.
  • Review old outstanding payables/credits to see if either payment was missed or if payments were misapplied.
  • Review your deposits received after year-end to make sure you applied payments to the correct customer and year.
  • Review old outstanding accounts receivable to see if an allowance is necessary for accounts that may not be collectible.
  • Update your capital asset listing for any disposals/deletions that have happened. This can be done by having each program/department/etc. do physical counts of their assets and submitting that to the finance department or selecting a lucky individual to verify the entire list.
  • Review year-end adjustments, usually prepaid, accruals, and current versus long term debt, which are required for the audit. This is the last part that has an impact on your findings if the auditor is the one posting these journal entries. Below are a list of accounts that are usually adjusted:
    • Prepaid rents, real estate taxes and insurance
    • Accrued payroll and taxes
    • Compensated absences
    • Long term debt (car and equipment loans)

Because you have accounted for your monthly procedures, your year-end procedures should become less burdensome since those issues were addressed throughout the year (and who doesn’t want an easier year-end?). With the confidence that your company gains from knowing you have reviewed and reconciled your financial information, you are able to concentrate on accurately and confidently preparing your financial statements.

Year-end work can be time consuming and sometimes tricky. If you need to save time or need help figuring out where to begin, let us know. Ours numbers nerds are no stranger to this type of work – and they even enjoy doing it!

 

Who Doesn’t Love a Discount?

Who Doesn’t Love A Discount?

If given the option to pay full price or receive a discount, it’s safe to say the majority of individuals would prefer a discount, regardless of what they’re purchasing. Why would this be any different when it comes to your business?

When valuing a minority interest in a business (an ownership interest of 50% or less), it’s typical of buyers in the marketplace or a valuation analyst to apply minority discounts, which are more technically known as a discount for lack of control (DLOC) and a discount for lack of marketability (DLOM).

We know what you’re thinking: what are these discounts and why do they matter? Here’s a look at each type:

A DLOC is an amount or percentage deducted from the operating value of an entity to reflect the absence of some or all of the powers of control. When someone holds a minority interest in a business, they lack the ability to:

  • Implement business and operational characteristics;
  • Appoint and remove management;
  • Control the timing and amount of distributions;
  • Put the entity’s assets to their highest and best use.

In other words, the person buying into the business is receiving a discount because they are not receiving the full benefits of control.

A DLOM is an amount or percentage deducted from the operating value of an entity to reflect illiquidity (inability to quickly convert to cash) in privately-held entities when compared to public companies. In the valuation world, we refer to liquidity as “cash in three days”, which is expected when selling publicly-traded stock. However, when it comes to selling private companies, it takes much longer than three days to receive cash, which is why a DLOM is appropriate.

Discounts are extremely important to understand when negotiating transactions with investors. Investors’ primary way to receive a return on their investment is through distributions, which are primarily dependent upon the company’s financial stability, and diversification among the services and/or products and geography of the business.

Going back to the concept of “cash in three days”, investors will also look at the obstacles they could encounter if they decide to sell their interest in the future, which could potentially be affected by the company’s transfer restrictions and redemption policy. Therefore, appropriately discounting a minority interest is important as it could potentially make or break a deal.

Of course there are some risks that should be considered on the sell-side of a transaction. The amount of time it takes to complete a transaction, accounting and administrative fees incurred and the probability that the actual sales price could be much less than the asking price are some sneaky issues worth keeping an eye on.

Not only are discounts important to consider when searching for outside investors, but they are also a strategic tool that can be helpful when exiting a business. In fact, if you’re planning to sell your business, there’s a good chance you might encounter these discounts. It’s important to understand them so you know what price you can realistically expect from the sale of your business.

It goes without saying that buyers appreciate discounts to the share price, but sellers may not. After all, everyone wants to get top dollar for their business. Buy-sell agreements are commonly used to allow a company or its shareholders to purchase the interest of a shareholder who decides to withdraw from the company for a specific price or by using a set formula to determine a price. However, instead of preparing for a smooth exit, many buy-sell agreements tend to cause more issues as the use of a set price or a formula may not consider the current economic and financial condition of the company, which could lead to legal (and expensive) issues.

An effective buy-sell agreement should include an explanation of relevant discounts and the requirement for an appraisal from a certified appraiser to determine the current fair market value of the company. A well written buy-sell agreement will help minimize misunderstandings and disagreements, ensure proper discounts are appropriately applied to the company value and make for a smoother transaction among all parties involved.

Buy-sell agreements and all pieces of the puzzle can be difficult to put together. Luckily, our business valuation team is trained and ready to help you conduct a successful business transaction. If you need help, just ask!