Warning Signs of Embezzlement & Practical Internal Controls

President Ronald Reagan once said, “Trust but verify,” echoing a Russian proverb to describe the American relationship with the Soviet Union. The saying loosely translates into proceeding cautiously when someone is supposed to do what they say.

These words of wisdom not only apply to working with foreign powers but also when employers entrust their employees with specific job roles, particularly when those duties pertain to handling and overseeing company funds.  

In the military, trust is everything. At war, betrayal by a fellow soldier could lead to injury or death. Betrayal by a fellow employee, especially when it involves embezzlement or theft, could lead to the death of a business, or at the least, a devastating blow to operating finances.

Embezzlement — the misappropriation of funds by someone entrusted with money — can take place in multiple ways and by employees in various roles. 

Funds can be transferred into an account controlled by the employee. Check or deposit amounts are altered. A similar-sounding business is started under a similar name as a well-known vendor, such as “Professional Roofing Inc.” vs. “Professional Roofing Co.” Small amounts of money are withdrawn to add up to a lump sum over time. Employees use the company credit card for unauthorized expenses.

Understanding what employee embezzlement looks like and how to implement internal controls demonstrates that a company takes the threat seriously.

Internal Audit

Survey: Internal Audit Staffing, Budgets Bounce Back

by Staff and Wire Reports

March 22, 2024

55% of audit teams using AI or weighing whether to adopt the technology

Read moreDetails

Warning signs of embezzlement

Nine out of 10 occupational fraudsters are first-time offenders and have never been charged or convicted of a fraud-related offense, according to the Association of Certified Fraud Examiners. 

Here are common red flags that can help stop internal theft before it’s too late:

• Unexpected financial discrepancies and transactions: Unexplained shortages in cash, inventory or assets; large or frequent cash withdrawals, suspicious payments or altered documents; missing receipts, invoices or other supporting documentation.
• Vendor and customer complaints: Vendors claiming they haven’t been paid or have received partial payments. Customers claim to have already paid the bill.
• Employee lifestyle changes: Employees live beyond their means, such as purchasing luxury items; employees experiencing financial difficulties; excessive overtime or weekend work without a clear reason; and refusal to take vacation.
• Resistance to external checks and audits: Watch out for employees’ reluctance to cooperate with audits or reviews of financial records and employees becoming defensive or overly protective about their work and devices.

Implementing robust internal controls

As employers, it is important to demonstrate a commitment to strong leadership that upholds a culture of integrity, ethical conduct and prevention of any kind of fraud, theft or embezzlement. Create a culture of open communication where employees feel comfortable raising concerns, and reward employees for ethical behavior and reporting suspected misconduct.

Remember that no system is completely foolproof, but implementing robust internal controls, being aware of warning signs of embezzlement and displaying ongoing vigilance and participation in your company’s daily activities, can mitigate most risks. 

You don’t have to micromanage, but you do have to manage. As Dutch said, trust but verify.

• Segregate duties: Ensure that no single person has complete control over financial transactions. Separate duties like authorization, recording and custody of assets and implement added security measures, such as management approval for wire transfers. Ensure that the person who signs the checks is a different person than the one who does the bank reconciliation. Put another way, whoever pays the bills never signs the checks. 
• Perform regular audits: In the military, they’re called pre-combat checks (PCCs) or pre-combat inspections (PCIs). Conduct audits, including unannounced inspections, to identify discrepancies and weaknesses in your financial systems. 
• Purchase insurance: Buy specific fidelity insurance to cover your employees.
• Install robust accounting systems: Use reliable accounting software and maintain accurate financial records. Implement strong password protection and access controls.
• Develop clear policies: Develop comprehensive policies and procedures for financial transactions, expense reimbursements and other high-risk areas. Implement strict expense reporting policies, including detailed receipts and approval processes.
• Train employees on fraud prevention: Educate employees about fraud prevention, ethical conduct and the company’s internal control policies. Inform employees that those who are caught cheating the company out of money will be fired immediately and fully prosecuted.
• Implement anonymous reporting system: Establish a confidential reporting system for employees to report suspected fraud or misconduct without fear of retaliation.
• Review vendor relationships: Review vendor relationships, payment processes, and invoices to detect irregularities. Also, be mindful of kickbacks from vendors who then overcharge the company; competitive bidding may also catch that concern.

This article was first published at AdamsandReese.com; an adapted version is republished here with permission.