One of the most vivid memories I have from when I finally became aware of what exactly my dad’s did for a living was when he learned his bookkeeper had been stealing from him. This had been going on for several months before his property manager became suspicious and started looking into the transactions closer.
My dad’s bookkeeper had been paying for her phone bill, new tires, and a host of other things on my dad’s account. In the end, she had embezzled over $5,000 from him. Not the worst loss in the world, but unfortunately, this kind of thing is all to common. And it can be much worse than what happened to my father back in the late ’90s. For example:
- “Accountant arrested for stealing nearly $6M from Hawaii nonprofit”
- “Former FBI paralegal sentenced for embezzling $250K”
- “West Haven mayor’s son charged with embezzlement”
- “DA: Ex-Oregon attorney embezzled funds to support her ‘lavish lifestyle'”
And on and on and on.
Will Yakowizc, writing for Inc.com, describes a recent study that shows just how damaging employee embezzlement can be. The results of which were:
“Smaller businesses are more at risk to employee theft. The report finds that 55 percent of embezzlement cases occurred at businesses with 100 employees or less, with an average loss of $1.3 million.”
Lose $1.3 million here, $1.3 million there—and sooner or later, you’re talking about real money!
Needless to say, accounting is extremely important for entrepreneurs. Still, it is sadly overlooked much of the time. And only is accounting extremely important, maintaining internal controls with your accounting, bookkeeping and accounts payable/accounts receivable is incredibly important as you start to grow. It is these controls that will safeguard you against potential fraud.
The first key thing to think about is what is called the “Fraud Triangle.” The Fraud Triangle has three key components which together increase the odds that an employee will steal from you. The three elements are:
- Pressure: Is the person in question under some sort of financial pressure that would be aided by stealing?
- Rationalization: Is there a way for the person to rationalize the crime? (I.e. is the boss a bad person or does the company make way more money on some product than is “fair”?)
- Opportunity: Is there an easy way for the employee to commit fraud or embezzlement?
Or in visual form, it looks like this:
Yeah, I don’t know why it has to be a triangle either.
Related: 4 Steps to Take When Scaling Your Real Estate Business Into a New Market
Anyway, it’s hard to look out for pressure. But regarding rationalization, this would obviously be another reason to treat your employees (as well as your contractors, vendors, clients and the like) well. You shouldn’t let them walk all over you, of course. But if you treat someone like garbage, the rationalization monster in them will very likely get to work.
We’re going to focus mostly on opportunity, though. For that, we’ll turn to the seven key rules for internal control accountants have come up with that guard against getting robbed by employees (or partners and, in some cases, contractors, vendors, and the like).
Download Your FREE copy of ‘How to Rent Your House!’
Renting your house is a great way to enter the world of real estate investing, but most first-timers (understandably) have a lot of questions. Fortunately, the experts at BiggerPockets have put together a complimentary guide on ‘How to Rent Your House’. All the skills, tools, and confidence you need to successfully rent your house are just a mouse-click away.
1. Separation of Duties
Do you have the same person work on accounts receivable and accounts payable? Do you have the same person prepare the books and audit them? Early on, some of this may be unavoidable, but as you grow, you want to separate tasks as much as possible (especially accounts receivable and accounts payable as if those are done by the same person, there is a great opportunity for an employee to embezzle money).
For small businesses who can’t separate all of these functions, sharing tasks between two or more people can at least mitigate this risk.
2. Access Control
This is simply controlling access to various parts of your accounting system. You should always have your accounting and property management software password protected (and the password should never be “password”). You should also keep sensitive financial paperwork under lock and key. And don’t just handout these passwords/keys to just anyone.
3. Physical Audits
This is literally counting cash or inventory to make sure everything in your system is actually there. You shouldn’t have much loose cash hanging around (and if you do, you should deposit it right now!). But you may keep certain things in inventory, like appliances and other supplies. If you do, you should definitely perform periodic physical audits. Shockingly, I’ve heard multiple stories about such things being stolen!
4. Standardized Documentation
The more you standardize everything, the better. That goes for paint colors in your rentals, as well as things like invoices, expense reports, time cards, etc. It also goes for documents that are solely kept online.
While this isn’t related to fraud, we require each of our contractors to submit their bid on our scope of work form. Earlier, we were always comparing apples to oranges as each contractor submitted their bid on a different form and each often left a few items unquoted. Those unbid items could often skew the price and were often hard to find and compare when we got more than one bid on a project. When every bid is on the same form, it’s easy to compare who bid more for what.
And this same principle goes for fraud prevention as well. It’s much easier for someone to pass off a false document if all of your documents look different. It’s also harder for you to review your records to find things that may have been overlooked if none of your forms are standardized.
5. Trial Balances
Double-entry bookkeeping is essential, but the books are only balanced once a month (usually). So, as SmallBusiness.com recommends, “Calculating daily or weekly trial balances can provide regular insight into the state of the system, allowing you to discover and investigate discrepancies as early as possible.”
6. Periodic Reconciliations
You should reconcile your accounts on a regular basis (I recommend at least once a month) to ensure the balances in your accounting system match the deposits and withdrawals on your bank statements and to find any irregularities. Finding these irregularities is often how fraud is uncovered.
Related: How to Motivate Employees, Contractors, & Just About Everyone Else
7. Approval Authority
Most property management companies won’t go over a certain dollar limit (often $1,000) for repairs without owner approval. I require that for any turnovers or rehabs over $5,000, our rehab manager must check off the scope and bid with me first. My brother looks over all of our outgoing checks before signing them and sending them out. I talk to my dad and brother about upcoming acquisitions, giving them a chance to veto them if need be.
The exact measures will differ from business to business, but you should build in approval authority safeguards for large transactions wherever possible. This will stop the worst types of fraud. After all, while small fraud hurts, big fraud kills.
While your business might not be at the point where you need to implement all of the above safeguards, you definitely need to start thinking about this as soon as you hire employees. Indeed, you need to think about it beforehand, as there are plenty of other people who can steal from you. Unfortunately, theft is a cost of doing business these days. But like with all costs, you want to do everything you reasonably can to keep this one as low as possible.
How do you ensure your business is protected against theft and fraud?