Blogs by William Manchee
Defending the Small Business. Part 9. Theft & Embezzlement
10/20/2008 4:07:18 PM
Employee dishonesty is a major problem with small business. Check out my novel "Act Normal" for an excellent and entertaining example.
A critical problem for SBO is finding people they can trust. Nobody can watch every employee every minute. There are a myriad of ways customers and employees can steal from you without being detected. Such was the case for Don and Ho Park, who brought their life’s savings from Korea and opened up a janitorial business in Arlington. They felt fortunate when a bright young woman answered their ad for a bookkeeper. She was kind and patient with them and helped them master the English language. She seemed to know all the ins and outs of accounting, payroll and tax compliance, so they left all those matters in her hands. Her salary wasn’t cheap but it was reasonable considering all that she did for them.
Business started out slow but grew steadily for several years as they acquired more and more customers. Even though sales were good and overhead was modest, they seemed to always have cash flow problems. Since they didn’t understand financial statements or bookkeeping they had no idea what was happening to them. Finally they started watching the bookkeeper a little more carefully and noticed the deposits she was making were for less than the receipts they were giving her. When confronted with this she confessed that she routinely took ten percent from each deposit and put it into her account. Over the years it had amounted to more than $50,000!
Don and Ho were shocked and horrified by this betrayal. When I suggested they go to the DA, however, they declined because as they were so humiliated by what happened and didn’t want anyone to know about it. I understood how they felt but didn’t relish the idea of letting the bookkeeper off the hook so easily. Eventually, Don and Ho were able to pull themselves out of the huge hole that their employee had dug for them, but only because they were running a tight ship and had a lot of friends and family providing a cheap labor pool. A more marginal business wouldn’t have been able to survive a $50,000 hit like they did.
There are other, more creative ways to embezzle which are difficult to detect. In a case in Desoto, a convenience store had been in operation for years when the owner, Pete Briggs, decided to move to the country. He turned over the business to a manager who had been with him for several years and he trusted implicitly. Over the next eighteen months or so he discovered his sales were down and wondered what was going on, since business had always been good at this store. When the manager was confronted about the shortage and poor sales he just shrugged and said times were bad.
Later when Peter asked his accountant about the losses, he told him that there was a serious inventory shortage. At this point we were hired to try to get to the bottom of the problem. When we started interviewing employees we discovered that the manager had systematically fired all the old employees and hired members of his own family to work in the store. He also conveniently disabled all the security cameras and claimed they were being repaired.
After inspecting cash register tapes we discovered that there were hundreds of voided transactions, which we suspected meant sales were being made, the tickets voided, and the money pocketed. Unfortunately, when we subpoenaed bank records, we couldn’t find any extra cash coming into the account. Since all the employees were related to the manager, they were uncooperative in our investigation. The only explanation we could come up with was that the manager was spending all the money that he was stealing. This certainly was possible, but there was a quarter million dollars missing, so we were pretty sure there must be a stash somewhere.
When we took the deposition of the manager’s spouse, we discovered she had her own small landscape business. The business seemed legitimate until we tried to find out who her customers were. She could only name a few and was very vague as to the jobs she had under contract. It soon became clear that the money being embezzled by her husband was being booked as the sales for her landscape business.
In going through her bank statements with her, I noticed several large withdrawals. When I asked her about them, she claimed it was her practice to withdraw large sums to purchase cashiers checks to pay bills. When I pointed out that on several occasions there were no cashier’s checks purchased, she admitted to storing the cash in her freezer until she needed it.
During all this time the DA couldn’t be bothered with the prosecution of an embezzlement case because he felt it would be too difficult to prove. Eventually the case settled and the client recovered $100,000 of the quarter million embezzlement. Fortunately for my client, his business had a prime location, so he was able to sell his business and recoup his money, but his was a unique case. Most SBOs couldn’t survive a quarter million dollar embezzlement, and I know of several who had to file bankruptcy after losing far less than that.
I could go on and on with more tales of employee dishonesty as it is very common. The point I want to make is that employee dishonesty usually occurs because the SBO is not paying close enough attention to his business. Employee’s should be carefully screened before they are hired. Resumes should be verified, criminal background checks should be made, and references checked.
Once employees are hired, it’s not wise to trust all of the accounting to one person. More than one employee should handle deposits, check-writing, and checkbook reconciliations. Spread the work around to make it difficult for one person to control the system. The owner should always review bank statements for irregularities. Monthly profit and loss statements should be created and routinely reviewed to spot unusual entries or trends. Blank checks should never be written.
I had one client who would routinely sign blank checks whenever she was out of town or on vacation. Her bookkeeper would then pay the bills as they came in. After a few years, when cash flow began to be a problem, the owner started to review her old bank statements. To her shock, she found she had been double paying vendors. When she checked with the vendors they denied being paid twice. Upon checking with the bank, it seems the bookkeeper had set up accounts with names similar to the vendor's and was depositing the extra check into her own accounts.
Usually the bank will have to make good on checks they accept with forged signatures, but in this case it was not that simple. The signatures were valid and the bank alleged that our client was negligent in signing blank checks. On the other hand, the endorsements were fraudulent and we alleged that the bank was negligent in letting this employee set up all these bank accounts in fictitious names. The dispute went into litigation which lasted for years. Eventually the case settled and our client got partial restitution, but the battle cost my client dearly in time, money, and mental distress.
In fact, the woman who had written the blank checks felt so guilty that she became obsessed with the case, calling me every day and sometimes several times a day about it. She wanted the money that she lost, but more than that, she wanted the bookkeeper to pay. The case was so distracting and mentally debilitating to her that she could scarcely work in the business after this happened.
Your accountant can recommend other measures to protect against employee dishonesty, and these measures should always be implemented. Many people blame their accountant for not detecting embezzlement, but usually the employee is smart enough to hide their handiwork so that the accountant won’t readily see it. It’s the SBO who has the best shot at detecting dishonesty, because he or she is there every day and should detect any irregularities.
If all else fails, the SBO can get fidelity insurance to cover any losses suffered from employee dishonesty. Generally the insurance is inexpensive and can be attached as a rider to a general liability policy. The sad thing I’ve found, however, is that very few SBOs have this type of insurance coverage.
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