Stop, Thief!

You can avoid countless problems by examining your company's practices in each of four areas:

1. Hiring practices. Ideally, you should begin thinking about employee theft prevention before hiring your first employee. In reality, though, first employees are usually hired at a time when the business is incredibly busy and little time is available to consider theft prevention. You may be so relieved to have some help, you don't even think about potential problems.

This is especially true when hiring a secretary/bookkeeper. You probably didn't go into business for yourself out of a love of record-keeping, and you may be overjoyed at finding someone to take over that responsibility. Because you are so eager to get this help, you may forego the normal background and reference checks and may give the new employee more responsibility than is prudent.

Take precautions when hiring. Begin by defining what it is you want in a new employee. Write a job description, and determine what education and experience are needed. Carefully interview several applicants, keeping in mind that character is more important than job skills. You can teach a person new skills; you can't teach good character.

Most people come to your company with good intentions, only to begin embezzling years later. However, some people who seek employment have crime in mind from the start. A job seeker may be someone who has embezzled in the past without being prosecuted. It's a simple matter to check on an applicant's employment history and to question their reasons for leaving each previous job.

If a former employer is reluctant to give detailed information, try asking, "Would you hire this person again?" Be alert to unexplained lapses in an applicant's work history. The applicant may be concealing a previous job to hide a problem.

When filling particularly sensitive positions, such as controller, bookkeeper or sales manager, consider performing additional background checks. These can include checking police records and credit histories. Many investigative firms can provide this information quickly and at a very reasonable cost. Considering the investment you make in a new employee, the cost of background checks is well worth it.

If your new employee will handle cash or do your banking for you, contact your business insurance agent about having the employee bonded. This is also known as employee dishonesty insurance; again, the cost is very reasonable.

2. Work environment. Promoting high employee morale and management ethics is critical to preventing embezzlement.

One advantage of owning a small business is you can get to know your employees well. Understanding how costly morale problems can be, you should always stay alert to potential problems brewing and take steps to nip them in the bud.

Management ethics refers to a company's code of morals and level of honesty, which is set by management and is demonstrated by example as well as by discussion. If your company normally deals with customers, suppliers and employees in ways that are unethical or seems concerned only with short-term profitability, this attitude will filter down to employees. The result? An increased probability of theft and fraud.

On the other hand, employees who see you returning overpayments from customers, telling the bank about errors made in your favor, and generally dealing fairly and honestly with others will adopt the same attitudes. Management sets the tone for ethics within a company. Remember, fraud is contagious, and many a business owner has taught young employees by example that dishonesty is acceptable in their business.

3. Internal controls. Internal controls are the procedures used to ensure the correctness and completeness of a company's accounting records, as well as to guard against fraud, theft and errors. These are what most people refer to as the "checks and balances" within a business. A weak system of internal controls is an invitation to embezzlement.

Ron Jennings has seen plenty of small-business embezzlements. The Corpus Christi, Texas, CPA recommends small-business owners incorporate at least the following minimal internal controls:

• Sign outgoing checks yourself.

• Open bank statements yourself. Examine the canceled checks; see if the deposits appear to be reasonable. Look for unusual debits, such as ATM withdrawals.

• Try to "segregate duties" between employees if possible. Segregation of duties means different employees perform the tasks of authorizing transactions, recording the transactions on the books and safeguarding the assets. For example, you might have separate people authorize bills for payment, write the checks and reconcile the bank account. Or you could have one person approve employees' timecards, another prepare the payroll, and a third distribute the signed paychecks.

Obviously, while segregation of duties works in some businesses, it has limited use in very small ones. If only one or two employees are involved in your accounting operations, you as the owner must take on certain responsibilities. It is essential that employees see you are involved in the financial aspects of the business. Employees steal only when they feel that they can do so without getting caught. By being involved in your company's financial operations, you reduce the likelihood that your employees will think they can get away with stealing.

If you truly cannot take the time to perform certain control tasks, you must at least give the illusion that you are watching over your company's assets carefully. This can be accomplished by opening the bank statements, questioning certain canceled checks and deposits, and asking occasional questions of employees to make it appear that you are more involved than perhaps you really are. Again, this "illusion" is no substitute for actual involvement in daily operations, but it's better than letting employees think they can steal without getting caught.

Requiring all employees to take at least one week's vacation each year is another important control measure. Many embezzlement schemes come to light in the absence of the schemer.

Devising a sound system of internal controls requires a good knowledge of accounting systems, as well as the ability to think like a crook. Most employers need the assistance of a good CPA to devise internal controls. The strength of these controls is the single most important factor in preventing embezzlement, so don't overlook this area.

4. Fraud awareness. Simply being alert to the possibilities of theft within your type of business is an important aspect of preventing embezzlement. Know the signs of embezzlement, and keep an eye out for them. (See "Red Flags" on page 150.)

By taking these steps, you'll not only protect your business's assets, you'll help your employees stay honest as well.

This article was originally published in the January 1996 print edition of Entrepreneur with the headline: Stop, Thief!.