Often a taboo subject open for discussion in franchise businesses is the attention given to controlling the risk of internal theft by employees.
The franchisor tends to focus on its role as a support function for its franchisee network and as a rule tends to put insufficient investment into its own internal controls when compared to a similar sized “non franchise” business. Outcomes of this lack of focus typically include an increased potential for higher level internal fraud by finance staff with multiple authorities for fund disbursement. The existence of a number of family type businesses operating as franchisors is another reason for deviation from having a strong internal franchisor controls and governance. As franchisors grow their reliance on trust in staff as a control becomes an increasing concern that should be addressed early in the development phase with a cycle of internal audits and control reviews.
Owner/manager businesses such as Australian franchisees are reliant on system generated controls rather than creating any separate processes to protect their assets. A lack of focus in this area is due to a number of factors including inexperience in managing retail staff, a strong degree of trust in employees that family run businesses promote and a lack of general training in controls when franchisees purchase businesses. Longer term franchise holders are clearly more focused on managing fraud risk than those new to the industry. This tends to be as a result of having been through the unpleasant experience of internal theft rather than being proactive. Furthermore in our experience businesses that grow too quickly without a control base being initially established have shown to be prime candidates for fraud which can demoralise a strong sales business faster than it has grown.
Accounting firm KPMG publish an annual review of fraud that is researched from over 2,000 Australian and New Zealand companies. Just on half the organizations surveyed suggest a fraudulent incident detected within the business in the last 12 months. The breakdown of fraudulent incidents that were detected relating to non-management or shop floor staff can be categorized into the following areas.
Many of the above issues are everyday possibilities for most franchise businesses in Australia. If temptation exists for sales staff then opportunities for theft are likely to be taken advantage of. Removing or reducing this temptation is the role of internal controls.
It is to be expected that both franchisees and franchisors have a significant top line focus with multiple strategies on how to further develop business opportunities. Areas of operational and financial control such as stock shrinkage rates tend to be thought of as consequences of doing business rather than the more important question of what can be done to reduce or even eliminate stock or cash shrinkage. It is often found that retail franchise businesses that do focus on stock shrinkage tend to specifically look at theft by customers rather than internally.
Large multi site retail businesses outside the franchise industry often have well established internal controls complete with criminal checks for new employees. Given the multiple ownership of franchised businesses a consistent approach to controls is not normally possible. Independent fraud risk assessments can offer a low cost and business specific picture on where fraud control gaps exist and solutions on how to address these gaps in a commercially acceptable way. Experts in retail internal audit and risk management have the experience of applying which controls would best fit a large range of businesses susceptible to fraud.
In the absence of a fraud risk health check it is strongly recommended that businesses review the following 5 functions for weaknesses that could severely erode bottom lines due to internal fraud:
- Cash sale refund procedures
- Authority of payments to third party suppliers
- Reference checks for new employees
- Regular independent cash to bank reconciliations
- Encouraging all staff to take regular annual leave
Throughout our many years of on-site audit experience in retail organisations, cash controls are both the most crucial and the simplest to create. While internal stock and asset theft are widespread, commercial reality suggests that if staff members wish to steal low value stock undetected they can usually manage this comfortably given the resource demands the most businesses experience. Taking stock out the back door and putting it in the car is still the most efficient way to steal stock but only for small amounts and on irregular occasions.
The real damage to a franchise business from the perspective of internal fraud is in the loss of funds through ineffective or non existent controls surrounding creditors and customers. Cash offers the highest degree of temptation and therefore the highest degree of risk and satisfies both of the underlying reasons for internal theft (from the KPMG study) being greed and gambling addictions.
This article appears courtesy of Optimum Assurance Group 8-Jun-2008