I just got off the phone with my best and oldest friend, John. He recently learned that an employee stole over $100 K from his business. It breaks my heart to hear of the trouble it’s caused him and his wife. The situation is especially disheartening as he is at the end of his career, looking forward to retirement. Fortunately, he will be OK, but It still stings.
John and I started our corporate finance careers together, working for the same employer. He had just earned an MBA. I was a few years ahead of him at our company while working on my MBA, part-time, after hours. After 20 years of building careers with major corporations, we both left for entrepreneurial ventures. John bought a small manufacturing business, and I became an Executive Recruiter and Management Consultant. Over the years, I advised John on many issues. He is the nicest guy you could ever hope to meet, but he has a fatal flaw. He is far too trusting. We have discussed this issue many times over the years.
Steps to Minimize Business Risk
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- Ensure that appropriate systems are in place.
- Appropriate accounting, and clearly states transactions.
- Checks and balances: Establish clear authority and accountability for transactions with Approval limits.
- Oversight: routine review by senior management of cash flow
My friend, Stan, confirmed that this issue is all too common. He told me about two recent situations regarding companies that lost control of their cash while trying to scale. One lost a lot of money to an unscrupulous employee whereas the CEO for the other was not focused on critical matters. One situation was a restaurant and lounge, and the other was a food ingredients manufacturer. The latter is a great example of a company losing control while trying to scale.
The company just mentioned is a food and ingredients business selling Hot Sauce, Barbecue Sauce, and Rubs. It is owned by a husband-and-wife team that wanted to grow their business. Neither had a relevant business background so they hired a CEO. Regrettably, this CEO proved to be incompetent. There was no discipline around forecasting sales and planning resource requirements. No one was evaluating contracts to ensure performance and the viability of the relationships. They failed to recognize the underlying risks which resulted in the loss of their manufacturing facilities. Annual Revenue rose to $3 Million, however, they lost their production facility and incurred $800 K of debt. Ultimately, the CEO was fired. The fundamental issue in this case was the lack of proper oversight. An Advisory Board to help provide guidance and oversight could have prevented these problems.
From time to time, even large established corporations suffer fraud from dishonest employees. This month it was reported that an employee of Macy’s concealed more than $150 Million of expenses over a three-year period. Reports did not provide details about this theft except to say that the person in question managed the accounting for small package deliveries. If this fraud can be perpetrated against Macy’s, it can happen to anyone.
If you are a small business owner with aspirations of building a bigger business, you must have a clear understanding of the business profile. Mitigating risks includes a combination of systems, processes, and procedures. However, without oversight, systems, processes, and procedures are useless. As an owner-operator, you must make time to review critical aspects of the business. You must know where your funds are going and in what amount. You must be familiar with your vendors and the terms of those agreements. A Big Red Flag is to see funds going to a vendor you don’t recognize. You must investigate that matter immediately. Another Red Flag is payroll checks for an unfamiliar employee. Small and large accounts payable can reveal problems. It is incumbent that owner-operators and senior executives build oversight into their daily routines to ensure compliance and minimize risk.
An Independent Advisory Board can be helpful. People who know your line of business can help you negotiate the most favorable agreements. They should have the experience you lack that will result in useful guidance and advice.
If you want to scale your business to become a bigger, more profitable enterprise, you must be mindful of the risk posed by dishonest employees. Trust, but verification must be a key operating principle!
Thank you for visiting our blog.
Jim Weber – Managing Partner, ITB Partners
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Before making any significant investment, competent business managers thoroughly analyze the opportunity. They will perform a financial analysis to justify the investment. The typical analytical model employed is a discounted cash flow analysis. The two major components of this methodology are the upfront investment and the ongoing cash flow from operations. The initial investment is straightforward. It includes the outlay for land, building, furniture, fixtures, and other startup costs to be capitalized. A cash flow analysis employs the typical expenses incurred in your existing outlets. The cost of Goods Sold and Labor vary with sales. Most other expenses are fixed, at least on an annual basis.
