[IMGCAP(1)]The dynamics of a family-owned business are like no other.
Work and family life can become so intertwined that it’s often hard to leave work at the office. Family members go home and eat and live together. A backyard family barbecue might evolve into an impromptu board meeting.
Undoubtedly, family businesses are a powerful, inspiring thing. Working with family means working every day alongside people you love and trust. It means creating a legacy for future generations and a highly respected brand in your community. I’ve greatly admired the strength of family businesses, and there are some amazing stories out there of family businesses spanning three, four or more generations.
However, the innate high level of trust among family businesses can occasionally create some major problems that compromise the business’s finances and longevity, including the often-overlooked issue of fraud.
Because of the entrusting, tight-knit nature among family-owned businesses, it’s not uncommon for one unsuspecting family member to steal money from the business. Who wouldn’t trust Cousin Eddie to manage the books or sister Rachel to oversee the cash register, right? They’re family. Everyone wants to believe their family members are the most trustworthy, ethical people around.
But when you think about it, this unchecked trust often provides a prime opportunity for a family member to steal without anyone questioning them.
Many times the family members working at family-owned businesses treat the business as though they’re entitled to profit from it today, or feel the family owes them money and is responsible for helping them through tough personal financial times. Instead of asking for the money, they just take it on the sly.
Here’s a not-so-uncommon scenario: Brother Joe handles all the accounting for the family business. That can be very challenging and stressful at times, especially when cash flow is tight. He secretly feels he has the worst job in the business and doesn’t get compensated enough for all the stress and burden it puts on his home life. Since he oversees all the company finances, who’s to stop him from taking an extra paycheck on occasion, or giving himself a little salary boost? So he does—and it may take months or years for anyone to notice.
That’s just one example of how fraud happens in family businesses. Here are some others:
• “Ghost” employees. The family member overseeing payroll creates “ghost” employees that do not exist and arranges for their paychecks to be direct deposited into their own bank account.
• Inventory fraud. Family members with easy access to inventory steal it and then sell it themselves for profit.
• Credit card abuse. Family members put personal expenses on the company credit card.
• Cash skimming. A family employee steals by slowly skimming cash from the cash register or cash box before it’s recorded in the company books.
• Fictitious vendors and suppliers. A family member creates a fake supplier or vendor—perhaps even a shell company—and then directs payment via check or wire transfer.
The reason it’s so easy for these types of fraud to happen is the weak internal controls at so many family businesses. The family treats the business too informally because it’s run by family members and nobody wants to suggest they don’t trust one another.
But if you’re not careful, fraud can eat away at the family business’s finances and eventually lead to its downfall. You’ve probably heard the stories. Given this high risk, it’s in your and everyone else’s best interest to make sure the family business stays strong—and the one way to do that is to put the right oversights and checks and balances in place. A CPA can help design these controls so all the bases are covered and fewer burdens are placed on family members to handle these often-sensitive topics themselves.
Here are some controls a CPA can help establish:
• Avoid signature stamps for checks. Family businesses should also consider requiring two signatures on large checks.
• Separation of financial duties. Bank statements should be opened by a family member other than the one preparing the bank reconciliations. Transactions and canceled checks should be reviewed by someone else.
• Review of supplier and vendor lists. The list of vendors should periodically be checked for fictitious names, and, if suspicious, should be further investigated.
• Review of payroll. Payroll should also be reviewed for unauthorized employees and unapproved pay by someone other than the person preparing payroll.
• Have more frequent business meetings about finances. Make sure all financial reporting is transparent. Even if the family business member is not a “numbers person,” they should still make an effort to try to understand.
• Establish clear expectations among all family business members. Be upfront with other family members on issues such as expectations, rate of pay and other benefits.
Instating financial controls at a family business may feel like you’re compromising the trust among family members by questioning it. But you shouldn’t view it that way. Establishing internal controls can actually build more trust among family businesses because it allows family members to feel confident that the business books and records are accurate and that everyone is being treated the same.
Robert D. Rothbort, CPA, CFE , is a partner at Armao, Costa & Ricciardi, CPAs, in Garden City, N.Y. He has over 20 years of professional experience in both public and private accounting, with expertise in tax planning, accounting, forensic accounting, estate planning and business succession planning.
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