After two years of economic turmoil attributed to COVID-19, many companies, including small and medium enterprises (SMEs), have run out of cash and hope. Thus, the incentive to cut corners, including those requiring questionable ethical considerations, has never been greater. Managing these challenging times requires the leadership of chief financial officers (CFOs), who are known for their strong ethical standards. By highlighting moral blind spots and helping to prevent potentially severe errors in judgment, CFOs have an essential role in supporting CEOs, cross-functional partners, boards, and owners..
Higher Risk of Fraud
The ACFE 2020 Report by the Association of Certified Fraud Examiners indicates that Small businesses (fewer than 100 employees) have a higher risk of fraud than large organizations. Specifically, there is a two-fold increase in the risk of billing fraud, a two-fold increase in payroll fraud, and a four-fold increase in check and payment fraud. But why?
Sadly, a few SME owners, CEOs, and other business leaders operate in gray areas or are unconcerned with the ethical implications of their business practices. These are the exceptions, not the rule. Instead, the increased risk of fraud and unethical business practices is mainly the result of a lack of awareness and the unique challenges faced by SMEs.
Ethical Awareness
CFOs and their teams of finance and accounting professionals are known for their integrity and trustworthiness. CFOs begin to develop ethical awareness in the classroom and solidify it by joining professional organizations that require adherence to their respective moral codes of conduct, such as the IMA Statement of Ethical Professional Practice or the AICPA Code of Professional Conduct. If CFOs do not abide by these codes and take part in ongoing ethics training, they may lose their certifications. As CFOs, their professional ethics are embedded in their DNA and continually reinforced throughout their careers.
We work with cross-functional partners who are experts in their respective fields. In addition to developing business leads and sales, they are also responsible for delivering products and services. Unfortunately, they often fail to consider the financial aspect of the business. They lack the heightened ethical awareness of the CFO, especially if they are not subject to a formal code of conduct within their profession or company. Therefore, they may experience moral blind spots or gaps between their intended and actual behaviors.
Unique Challenges
It is common for members of the management team and other employees to wear multiple hats; some, but not necessarily all, are within their areas of expertise. A strong personality and high self-confidence may prevent the founder or CEO from accepting feedback. A board of directors dominated by the founder or CEO, other internal leaders, and personal friends may not provide adequate oversight.
Additionally, small companies tend to have minimal internal controls. As a result, responsibilities are often not separated. If they exist, many policies are undocumented, resulting in inconsistent application and favoritism. Relationships between vendors and customers may become chummy or overly casual overtime. Potential conflicts of interest may go unnoticed.
Last but not least, lower salaries often make it challenging to hire and retain highly qualified, experienced candidates. The nature of SMEs poses various challenges that, unfortunately, increase the risk of fraud and unethical business practices.
What to Do
An organization’s CFO should play a leading role in building ethical awareness and addressing its unique challenges, including factoring in the following:
- Set the tone at the top: Define the organization’s values, operating philosophy, and standards of conduct; describe these in values statements, ethical codes, company policies, and communication. Moreover, the CEO, CFO, and other leaders must demonstrate consistency between their actions and those expectations.
- Code of conduct: To significantly increase ethical awareness, formally document the company’s code of conduct, train employees on how it applies to real-life situations, and require the employees to acknowledge that they understand and follow it.
- Governance: Appointing a board of friends is poor governance and will likely hurt the organization over the long term. It is necessary to appoint both knowledgeable and independent directors to provide oversight, challenge management, and act as a sounding board, notably when subject matter expertise is lacking.
- Documented Policies: Procedures must be clear, concise, and consistent. Identify critical policies and report them. In the absence of formal guidelines, identify a starting point (e.g., policies on segregation of duties, delegation of authority, conflicts of interest, and travel reimbursement). Over time, these policies can be refined as necessary (for example, policies that are impacted by technological advances and the transition to remote and hybrid work should be revisited).
- Segregation of duties: Analyze the roles and responsibilities and determine the most critical risk areas. Consider investing in cross-training (for example, cross-training your payroll associate, requiring the back-up to run payroll at least quarterly).
- Internal Controls: Strengthen internal controls, especially in high-risk areas such as cash, payroll, and customer billing. Suppose you wish to minimize the risk of checks(Cheque) and payments being tampered with. In that case, you should address segregation of duties concerns, utilize the check (Cheque) logs provided by your bank, and review account reconciliations promptly.
- Financial Reporting: Ensure that financial closings are completed on time and accurately. Leverage closing checklists. Once prior periods have been closed, they should be locked. Conduct a thorough review of the financial results, including variance analysis. Provide timely reports and ensure management is aware of them, including their responsibilities. Also, it would be prudent to seek the assistance of a quality CPA firm to audit financial statements rather than relying on the services of a friend to prepare the reviewed financials.
- Vendor and Customer Relationships: To prevent the development of unhealthy relationships with vendors and customers, consider having multiple contact points. Furthermore, clarify the policies regarding accepting or giving gifts to such partners. Finally, it is imperative to establish clearly defined conflict of interest policies and require all relevant personal relationships to be disclosed.
Adapting to the ever-changing world requires companies to think fast and remain agile. Such strategies must be applied in the real world. GL International helps clients develop strategies based on the knowledge of doing and not just knowing.