The risk of fraud is greatest in this period of a downturn in the economy when the financial pressure on a business increases.  The current state of the anti-fraud program  must be evaluated to minimize the duration and potential loss.  You should evaluate the current state of the anti-fraud program and the preventive measures as well as the detective measures that are implemented.

According to a report to the National Association of Certified Fraud Examiners, companies lose an average of 7 percent of revenues through fraud.  This is hard to measure when you consider the intangible such as brand name, loss of reputation and a deteriorating employee morale.  Despite the many efforts a company takes to detect fraud, over 60 percent are identified by accident or by a tip.  It is extremely difficult to identify the fraudster since more incidents are committed by longer term employees with no history of committing such acts in the past.

Small Business Owner’s Characteristics

Small-business owners are different from their counter-part in the large corporate world.  They tend to be hard-working, highly focused, smart and tenacious.  They have to be since businesses with fewer than 20 employees have only a 9 percent chance of surviving a decade.  Some are successful despite themselves, but fail when it comes to the planning stage.  Their tendency to hone intensely on their business results in them neglecting their personal financial planning.

Employee Benefits

They do not implement proper benefits, such as retirement plans, life and disability insurance and health insurance.  Too many small business owners fall into this class.  Benefits are often a low priority when one begins a business.  Costs may be prohibitive and such benefits are not reconsidered, however the absence of such benefits can play a crucial part in the difficulty of recruiting and the quality of new employees.  As a company grows, they may qualify for discounts that would greatly reduce the expense/employee.

Providing for Family

If the unexpected occurs, they have not properly provided for it.  They probably scrimp on disability or life insurance.  They think that because their business may be worth millions, their family will be taken care of after the business is sold.  This could be a very time consuming process and the business could be worth far less without them.

Saving Money Outside of Business

Small business owners may fail to save for their future because they are so focused on their business and pour money and time into it.  Growing and prospering override saving.  This may be why small business owners work far longer than they planned to –well into their 70s and even 80s.  They never drew sufficient cash out so they would have no other choice but to continue working.

Steps should be taken to prevent this outcome.  Retirement plans need to be funded during profitable times and investments made in a diversified portfolio.  Diversification can help lead to a comfortable retirement.

Business Credit and Loans

Many small business owners rely entirely on personal credit to finance their business venture.  They do not use business loans or establish business credit early on.  Personal credit may be the only option when starting a business but steps should be taken as soon as possible to secure proper financing as the business grows.  Unless owners sink their own finances into the business, growth will be stymied.  It is recommended that a minimum line of credit be secured early on in the business name.  This should be increased over time to show banks and other institutions of the ability of their cash flow to support such credit.

An internal control warning letter should make businesses aware of certain safeguards.  They should be warned against assigning related duties to the same person.  It is recommended that the bank statements should be scrutinized every month, with particular attention given to the reconciling items.  The check signer should look at proof of all purchases by having the purchase order and receiving attached to the invoice and check to be signed.  By providing a detailed internal control study, a company will help protect itself against fraud.  This would also benefit the accounting service provider by reducing deficient internal controls.

Another type of service to help insure good internal control practices would be one surprise bank reconciliation per year.  This will provide a measure of protection over the cash assets.  People who might be tempted to steal from the account will be deterred, with the knowledge that the bank statement will be examined.  This would include the proper procedures of comparing signatures of check signers to those on file, examine the endorsements to check register, etc.

Implementing the above mentioned procedures can help prevent the need for far costlier forensic services.  Such services would be required upon any suspicion of impropriety, and it would be very time consuming.  This would interrupt the normal operations of the business.

When gauging the financial health of your business, you should use ratios rather than absolute numbers.  Profitability, liquidity, operating and solvency ratios should be considered.  These ratios could alert you to trends which would require immediate action.

Profitability Ratios

The Gross Profit Margin measures your profit at the most basic level.   Is your sales price reasonable based on the cost of what you are selling?  If this ratio is less than one,  you will never make a profit.  If you sell your product for less than it costs, profitability will not be possible.

The Operating Profit Margin measures your profit based on your earnings before interest and taxes.  It measures the efficiency of the business before considering any financing.  When comparing the operating efficiency of similar businesses, this ratio can determine the most efficient one.

The Net Profit Margin is also referred to as the “bottom line”.  It considers all expenses including interest.  The net income is also referred to as the “bottom line”.

Liquidity Ratios

These ratios refer to the ability of an entity to obtain cash to satisfy financial obligations.  Liquid assets would be found in the current assets section of the balance sheet.

The Current Ratio would determine whether your working capital is sufficient to meet your short-term obligations.  A current ratio of 2.0 is a general rule, but this would be subject to the particular industry.  Some industries are more capital intensive.  A current ratio less than 2.0 might indicate difficulty in paying current obligations.

The Quick Ratio or “Acid Test” helps gauge your immediate ability to meet our financial obligations.   It does not include inventory in the current assets.  A Quick Ratio below .5 might be indicative of a shortage of working capital and difficulty in meeting current obligations.

Operating Ratios

The Inventory Turnover Ratio indicates the number of times the inventory “turned-over” during a given period.   A higher ratio would be preferable and indicates that you are not holding an excessive inventory level in your warehouse, and accumulating costs that accompany it.

The Sales to Receivables Ratio measures the turn over of your receivables.  The higher the number the better, which would indicate an efficient collection of receivables.  A ratio that is too high or increasing over time could indicate an inefficient use of working capital.  Like many of these ratios, they should be compared to similar companies in the same industry.

The Days Sales Outstanding measures the efficiency of your collection efforts.  The lower the number the better, and if the number is increasing, more effort should be directed toward collections.

The Return on Assets is one of the most common financial measures and an effective tool to compare the profitability of two companies.  A lower number may indicate that you found a more efficient way to operate through inventory management, quality control, financing, or technology.

Solvency Ratios

The Debt to Worth Ratio may also be known as “Leverage Ratio”.  It describes how much debt is used to finance the business.  It is never advisable to depend too much on debt financing, which can increase risk, and in addition, the related expenses can overwhelm a business.

Working Capital (Net of Current Assets and Current Liabilities) is used to gauge the ability of a company to weather difficult financial periods.   This number, unlike all of the above, is not a ratio but an absolute amount.  It is difficult to predict the ideal amount of working capital for your business, but an increasing trend should be considered a positive sign.