Forensic bookkeeping is not as ominous as it sounds. It has nothing to do with murder and criminal forensic studies of dead bodies. Yes, it has to do with criminal activity, but it is financial activity. But modern forensic accounting is even more. It looks at shrinkage, as a whole, and explores causes.
Forensic bookkeeping is vital to profitable business operations. Properly done and regularly conducted, it can catch fraud and theft early in its evolution and, more significantly, prevent them from occurring.
Some estimates place the effectiveness at eliminating theft between 3% and 12%. For a $100,000-per-year business, that’s as little as $3,000, and for a $200,000 operation, that’s as high as $24,000 in recovery or loss prevention.
And, for the micro-business, a forensic bookkeeping audit is as good as a high-end forensic accounting audit, costing around $50 per hour instead of $250.
Yet quality forensic analyses also help steer your business more successfully. This applies to multi-national corporations, all the way to mom-and-pop sole proprietorships.
Many businesses will never experience internal theft losses of a significant amount, but more than 2/3 of all businesses will experience some form of shrinkage at the hands of employees, suppliers and customers. However, theft is not the only concern that can be addressed through forensic audits. Inadvertent loss also shows in proper examinations.
One of the key tools in a forensic audit is a yields analysis. Portion controls also are a part of the equation. So, does that make the bookkeeping monitoring primarily a tool for the hospitality industry and restaurants? No.
Another tool is margin/markup checking, while another is inventory flow. So, does that make the forensic analysis primarily a retail tool? Again, no.
Forensic accounting examines payroll and work output. Does that make it primarily a tool to control budgets? Once again, no.
Forensic bookkeeping is invaluable to any type of business, properly conducted.
Many of us assume that in-depth examination of financial records is costly. That, too, is not true. A basic audit may take less than a few hours each quarter, and once proper controls are in place, may take even less time.
While accountants, and, particularly, tax accountants, look for compliance with tax law, they often do not perform an analysis role, other than to ensure bookkeeping is done according to established standards.
Forensic bookkeepers, on the other hand, are looking for clues, in much the same way that a homicide investigator looks for clues to identify suspects. It is not so much conformity to standards as it is deviant or unusual transactions that may seem innocuous.
Yet forensic accounting is only one half of the best technique for ensuring profitability in your business. While a comprehensive program may also include trends and patterns related to sales, costs and profitability, the other half of the program should include actual field analysis and hands-on investigation, to either verify or challenge the assumptions made by a forensic bookkeeping audit.
The two—an audit and an investigation—will uncover and resolve almost all situations of shrinkage, from theft and fraud to management and sales. Both, combined, may cost under $1,000 for a typical five- to ten-person business, yet may increase profitability from 3-12%. That makes the dynamic duo an incredible value.
To be most effective, though, the two tools should be used in the proper sequence: a summary forensic bookkeeping examination, followed by an investigation if salient anomalies are detected. Then a comprehensive audit to verify discrepancies, with implementation of controls to prevent reoccurrence of problems.
Following this sequence of quick overview followed by covert surveillance and analysis in tandem will allow you to identify probable sources of shrinkage, followed by a targeted investigation, with possible recovery of losses.
If no obvious or significant issues are detected, the next step would be to implement the proper controls to deter loss.
Both audit and investigation have three objectives: detection, deterrence and response. Deterrence is, by far, the preferred result, as businesses rarely recover all of the losses they have incurred through theft, fraud, or inadvertent error.
Ideally, small businesses should conduct regular audits. Annually, of course, to coincide with tax preparation. Then, quarterly, at a minimum. The person or company conducting these forensic audits should not be the same entity that does your regular bookkeeping and payroll, nor should any other persons involved in the financial chain be conducting the reviews. The audit should be conducted by an external source.
Reviews should not be predictable, either. Predictability and a regular schedule allow for any deviant person to cover their trail more effectively.
Yet each review should be relatively comprehensive, considering the size, structure and type of your venture.
There are numerous components to these reviews, focusing on specific areas of your operation. Payroll (of which labour costs are a part), of course, is always a vulnerable area. Next, portion control and supplies (operating expense) relating to sales. This is part of both inventory management and service costing. Whether it is tools and supplies in a trades business, paper costs in a restaurant, consumables in a hotel or consumable supplies in a manufacturing environment, cost of service is as important as cost of goods in a retail setting. That leads to COGs, or expenses associated with inventory in retail as an area of concern. Even utilities costs, from fuel and energy to internet and cell phones, need proper monitoring. Wastage, returns, damage and other incidental expenses affect profitability but also can indicate theft or fraud. Supplier and customer management tools prevent collusion and unintentional loss.
Each of these tools usually takes only moments to record or monitor yet may prevent thousands of dollars in loss.
Next, the investigation.
Investigation, in any forensic assessment, looks to specific suspects, whether the suspect be human or a process. By using the audit to identify risk areas and then zooming in on those targets, you can conduct a much more sophisticated and controlled detection and recovery operation.
Some sources (particularly large accountancy firms) would have you believe that only a comprehensive, high-end analyses are sufficient. That’s a little like installing a $75,000 alarm and security system to protect your $500 woodshed. The type of protection you need is commensurate with the value of the assets you are protecting and the likelihood that they will be targeted for theft.
That is good news for sole proprietorships, unincorporated partnerships, small businesses and independent local operations.
If, for example, a small specialty retailer employs a forensic bookkeeper, that bookkeeper may only need to examine a few things for potential theft, such as supply lines, inventory cost, payroll and soft costs associated with operating expenses, excluding such things as planning for financing, investments, cybertheft (except for basic prevention & awareness), and competitive placement that would be the usual domain of multinationals.
A local restaurant might focus on labour, yields, energy costs, and leave taxes to the regular year-end accountant.
A trades company might want to look at vehicle & tool expense, average hourly charge per project, favoured clients and billable hour profitability.
By focusing on likely situations, the business can mitigate costs of the audits, turn to a simple investigation to verify or rule out suspected problems and then refine areas of concern identified in both the audit and investigation.
This process dramatically reduces investment costs in the audit process, making forensic bookkeeping not only affordable for micro-businesses but also vital.
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