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Effective Internal Controls for Cash

All businesses should have internal controls to deter fraud, detect theft, and preserve assets.  Of all the assets, cash is the easiest to misappropriate.  Effective internal controls for cash prevent the proverbial hand in the cookie jar.   So how does a small business develop internal controls for cash?  What are good cash control systems and finally, how does the owner know if cash has been misappropriated?

Cash controls are considered an accounting system.

Before going into details about internal controls over cash, it is important for the extremely small business operation to understand that controls may not be needed.  If your business is a one person or just a few folks and as the owner, you get all the mail and all the receipts, you don’t need internal controls for cash.  It’s simple:  How can you steal from yourself?  Seriously, if you want to take your own money, it is not a crime.  Actually, I endorse this; after all, you did work for the money.  But once you reach a size whereby others come in contact with your money or handle the money in some way, you will now need to create and implement internal controls to prevent and detect fraud.  Internal controls over cash preserve this valuable resource of capital.

Internal Controls for Cash

Cash is divided into two separate functions.  The first is the receipts side of equation.  Here all sales and payments on accounts are received and process.  So a set of controls is designed to manage this function.  The second function is disbursements or cash payments out of the bank account.  Again, here a separate set of controls is designed to ensure proper disbursement of cash. 

For the small business, internal controls begin with the owner.  Good management ethics and integrity lead the staff towards proper handling of cash in the company.  The following are the different tools every business uses to control cash:

Separation of Duties

Separation of duties is the number one tool endorsed by American Institute of Certified Public Accountants, the governing body of CPA’s.  The key to this function is that the staff members receiving or managing the collection of money does not get involved in the disbursement of money. 

For cash receipts, ideally, all payments would arrive in the mail and the person opening the mail stamps the received date or places the company’s ‘For Deposit Only’ stamp on the back of the check.  The check(s) is logged in a spreadsheet and totaled for that day.  From there the check(s) is transferred to another staff member to copy and prepare the deposit ticket.  The deposit is made on the same day as receipt or first available opportunity the next morning.  Try not to have checks lying around overnight.

If involved in retail, restaurant, or some cash service business, the cash register should be reconciled by the register operator and then reconciled by management that same day while the operator watches.  To ensure that the cashier did their job correctly, have a policy notice to the customer that basically states that if the customer does not get a receipt, the purchase is free.  This forces the cashier to create a sales ticket. 

In your smaller business operations, this is difficult to achieve because there isn’t enough staff to comply with the separation of duties.  So the best backup is the two person rule.

Two Person Rule

Another effective internal control is the two person rule.  Ideally two people process the cash receipts together, generate the ledger together and fill out the forms together.  Once the total deposit is calculated, the deposit can be made by one person.  However, the deposit slip is sent back to the other person for confirmation of the correct deposit amount.  If a truly small business, all of this can be managed by the owner or the owner’s spouse. 

The two person rule is used in all aspects of handling cash whether on the receipts side or on the disbursements side of the equation.  A third party independently confirms the matching of receipts to the ledgers and sales or on the disbursements side; amounts owed to checks disbursed and cashed.  This third person usually reconciles the checking account for confirmation of all activity.

On the receipts side of the equation, two people count the till at the end of the day and verify the amounts in checks, credit card tickets, and cash (less the beginning cash balance in the cash register) matches against the sales for that day.  If they do not match, the discrepancy must be resolved prior to management reviewing the end of day cash register accounting.

On the disbursements side of the management of cash, one person generates the payment listing for the accounts payable and generates the checks.  Another person reviews the work and matches this against the accounting software ledgers for both cash and accounts payable to confirm no secretly printed check disbursement.

Finally, a third person, usually the owner, signs the checks once they are cut.  This person should review the disbursements ledger and the corresponding invoices and checks prior to signing the check.  This is known as separate or limited bank account signers.

Limited Account Signers

Every really small business should have one signer for the account and a backup (spouse, trusted family member) to sign checks.  As the business grows, it will become necessary to have another signer on the account to fill the void of the owner’s absence.  In addition, there are many times when checks have to be cut on the spot or in an emergency.  This signer is usually somebody in the accounting department or in upper management.  No matter who is assigned this task, the owner should conduct a background check and get that person bonded against potential embezzlement. 

A secondary backup to this system is a dual signature account requirement for any amount over a reasonable amount (about $2,000).  There is a fee associated with this with most banks, so depending on the nature of your business and the volume of staff, this may not be necessary. 

The best management tool for the bank account is the owner’s daily review.

Account Review

In addition to the above forms of internal controls, the owner should access his cash account each day online and review all the checks processed including those signed while absent.  Modern day online banking allows for the owner to review the checks as they are processed from day to day.  This is absolutely the best tool available to the owner to discover misappropriation of funds.

In addition to the owner, the accountant or bookkeeper should reconcile daily or at least weekly.  This individual should not have signatory rights on the account and this allows for the raising of any concerns.  This is a reflection of the two person rule above.

Finally, pay your CPA to spend an hour looking for any unusual activity in the accounts and ledgers.  Most CPA’s will stratify the data and then randomly sample more of the items in the higher range of dollar value to get a warm fuzzy that there isn’t any inappropriate activity.   This is known as a limited scope internal control review.

Summary

Future articles will describe in detail and provide examples of the various tools above for different industries.  The Separation of Duties is done differently between a retail oriented business activity and a manufacturing business.  So these details are illustrated in future articles for both functions of cash (receipts and disbursements).

Internal controls for cash rely of several tools.  The best tool is management’s constant and consistent monitoring of the bank account.  Other tools include separation of duties, using the two person rule to receive cash and process payments, and finally using a limited number of signers for the checks.  When all these are used together, the small business owner can feel reasonably assured of proper deterrence, ability to detect theft and preservation the valuable asset of cash.   Act on Knowledge.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org.  I would love to hear from you.    

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About David J Hoare (408 Articles)
I spent 12 Years as a Certified Public Accountant, Over 20 Years of Practice in Accounting and Consulting, Controller in Management of Closely Held Operations, Masters of Science in Accounting, Prepared over 1,000 Business Tax Returns and Hundreds of Individual Returns

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