By Donald Smith
Let’s talk about risk.
We’re all comfortable with at least some degree of risk in our lives. We leave our homes in the morning, risking traffic delays and unplanned encounters with other vehicles. We continue to drive our cars long after the warranty has expired. We may risk damage to our furniture or other property due to the actions of children and pets. It’s theoretically possible to eliminate any risk that can be identified, but most of the time it’s neither feasible nor desirable to do so.
If we are in business, we have other risks, and some of them have the potential to really mess up our lives – not just economically. There is the risk that our investment and effort won’t pay off, and we’ll lose money. There’s the risk that a customer will default on his or her obligation. There’s the risk that an employee will act against our interests, or get in an accident, or get sick and not be able to complete an assignment. A supplier could fail to deliver important components on time, and we lose a customer because we can’t meet a deadline. Assumptions underlying one of our estimates may be faulty, and we could be forced to complete the project at a loss. Or worse than all of the above, our bookkeeper could fail to pay our payroll taxes, and the IRS could come in and shut us down.
Dealing with risk is largely a matter of understanding our tolerance, and evaluating the costs of mitigation against the likelihood and severity of a possible adverse event. We purchase automobile insurance so we don’t lose our assets if we somehow negligently cause an accident. We carry insurance on our homes so we won’t be left destitute if there is a fire. We pay for antivirus protection and online backups for our computers, because the likelihood of a data loss from hardware failure or malicious software is significant, and the impact of that data loss would be severe.
When running a small business, there is a bundle of risks associated with accounting and bookkeeping that can be mitigated at a low cost compared to the losses that could otherwise occur. This bundle includes the following related items:
- The risk of faulty or untimely information, which can result in lost opportunities, inefficient spending, or tax penalties.
- The risk of material misstatements in financial reporting (including tax returns), resulting in penalties or defaulting on loan covenants.
- The risk of undetected error or fraud, resulting in a loss of assets.
Accountants tend to focus on internal control to minimize these risks. Internal control refers to the systems, procedures, and environmental factors that serve to ensure that financial information is timely and reliable, and that employees are doing their jobs rather than acting in their own interests. One key element of internal control over accounting is segregation of responsibilities, so that no single employee has the ability to divert assets, or cover up fraud, and that the work of one employee provides a natural check on the work of another. The classic formulation is that authority to authorize a transaction should be separated from recordkeeping for that transaction, which is further separated from custody of the assets involved, and yet again from the responsibility for verifying or reconciling the assets to the accounting records. This separation of duties is less important when one or more of the functions are performed by an owner of the business, but other than an owner, no single individual should handle more than one of these functions. The person that buys things should not prepare vendor payments, and that person should not be able to sign checks. A fourth person should reconcile the bank account and verify the balance in the accounts payable ledger.
When your business reaches the stage where you need someone in the office full time, the temptation is to make that person a combination office manager/bookkeeper, and give them responsibility for both record keeping and reconciliation of accounts. Sometimes they even has access to a signature stamp, and can prepare and send out vendor payments (or payroll checks) as needed in the owner’s absence. No matter how trusted this individual is, this is an invitation for fraud, as well as a breeding ground for sloppy accounting and the errors that inevitably spring forth in such an environment.
When there isn’t enough work to justify multiple administrative employees in the office (which is needed for separation of duties), often the most cost-effective way to minimize the accounting-related risks is to outsource some of the accounting workload. With an outside service handling the higher level functions, you can have your office manager focused on operations and customer service, while the outside folks review the office manager’s data entry work, reconcile the accounts, and make sure all the legal requirements are met. Outsourcing bookkeeping and payroll functions allows you to limit the level of access your office manager has to sensitive financial information, and lowers the specialized skill level in accounting that individual needs to have in order to function. It is a waste of resources to have a professional accountant answering the telephone, and it is an enormous risk to have an administrative employee in the office, communicating regularly with all your employees, customers, and vendors, who is at the same time working with sensitive payroll and other financial information.
Outsourcing payroll and bookkeeping functions can help minimize your financial risk, and maximize the cost-effectiveness of your office staff. Ready to outsource? Give us a call. We are happy to help.