How to put your company in the best position to raise capital

Today’s investment environment in Ohio, especially in its major cities, is very strong. Investors — individuals, companies and firms — have a lot of cash and want to grow and they’re looking for opportunities to put their money to work.

“There’s a big appetite for investments,” says Michael Stevenson, managing partner at Clarus Partners. “Making the right pitch to the right people can make that money accessible.”

Smart Business spoke with Stevenson about raising capital at different stages of a company’s life cycle.

What are the most common reasons businesses and startups raise capital?

Established businesses typically raise capital ahead of an expansion, when they’re looking to buy a business, start a new service or launch a new product. There are also balance-sheet needs, for instance when a company wants to shore up its balance sheet for a potential sale, so it pays down its debt with capital. Established companies also use capital to diversify their ownership holdings, providing aging owners more latitude to put their money elsewhere while giving other investors an opportunity to buy in.

Owners of startups often invest a lot of their own money into their fledgling company. As they grow, their working capital needs increase, but their money is tied up elsewhere, so they’re in an illiquid position and they need outside capital to shore up their working capital and pay employees.

What types of capital are being sought?

Existing businesses are pinning their capital hopes to Small Business Administration or commercial loans. These are the top choices because existing businesses have the equity to back a line of credit or term loan. Their cash flow, or the increase in cash flow expected from the capital injection, gives the lender the confidence that the loan will be paid back within the term.

For startups, they’re looking for angel investors, which typically want to invest in a company but don’t want an ownership stake. Rather, they want 20 to 30 percent return in exchange for taking the risk.

Who should businesses and startups seek advice from before raising capital?

Accountants can put together a plan that accurately quantifies and identifies the company’s capital needs, which is important because investors and banks need a number when looking to back a venture, and they need a rationale to commit.

An attorney can help the business as it builds and shapes its management team, which is important because banks and investors are throwing their money behind people, particularly people who they believe can manage the business to success.

It’s also good to involve an attorney in the formation of the business plan. They’re skilled at telling concise stories with information that’s the most relevant to potential investors.

How do startups connect with investors?

Startup owners need to go out into the community — via chambers of commerce and other economic development organizations — to make connections. They’ve got to get out and tell their story to people in the community. It increases the chances that they’ll meet an investor looking for an opportunity.

What should startups keep in mind when pitching investors?

Whatever the business thinks its capital needs are, double it. A startup doesn’t want to be in a position, having received an investment, of having to go back to the investor and ask for more money. That hurts the business owner’s credibility and makes it seem as if he or she doesn’t have a complete understanding of the company’s needs.

Also, investors want the business’s story. The numbers are important, but revenue streams and markets change so rapidly that forecasts become useless. It’s better to differentiate the business from others in the same space. Prepare a deck when raising capital to tell the story of the company.

It’s really important to have a full and complete understanding of the business. Owners need to be able to answer investors’ questions quickly and completely to prove that they understand the business and the marketplace in which it operates to convince finicky investors that the company is worth the risk.

Insights Accounting is brought to you by Clarus Partners

How to navigate the benefits and risks of opportunity zones

Opportunity zones have captured the attention of many. This program, developed under the federal tax reform, is a tax incentive to develop distressed areas. Investments are made through a qualified opportunity fund for the purpose of investing in these assets.

“There’s quite a bit of interest, seeing what’s on the market, what it’s going to cost and the projected benefits,” says Jim Komos, tax partner-in-charge at Ciuni & Panichi, Inc. “I think it’s going to reawaken projects that didn’t make economic sense before.”

Smart Business spoke with Komos about this innovative program, which is designed to promote development in economically distressed areas by delivering tax benefits to investors.

How are opportunity zones different from programs that have been tried before?

To create opportunity zones, states took census tracts with low property values and decided where they want to encourage development. It’s broader in scope than prior programs. Empowerment zones or renewal communities might have picked 40 or 50 qualifying areas. More than 8,000 opportunity zones have been identified throughout the U.S. and its territories.

The program also isn’t subject to as much bureaucracy as other programs, such as the earned income tax or new market tax credit. Opportunity zones are much simpler.

Who benefits from opportunity zones?

Property owners and residents are one beneficiary. Property is worth more and residents may see their neighborhoods spruced up with new facilities or construction redevelopment. In some cases, business owners who have been wanting to move may now be in an opportunity zone. This program could open up the market.

Developers and investors benefit in three ways:

1. They can defer taxation on capital gains for up to 10 years if they invest in an opportunity zone. However, those gains must incur within six months of the investment. Many investors are looking at opportunities within the zones prior to incurring a gain — selling a property — and creating the related opportunity fund.

2. If they stay in that fund for at least five years, 10 percent of that gain is eliminated. If they stay for seven years, another 5 percent is wiped off the books.

3. If they have gains on their opportunity zone investment, it will not be taxed. For example, an investor buys a factory for $1 million, and then sells it for $2 million 10 years later. That $1 million appreciation will not be taxed.

What restrictions could limit who can benefit from opportunity zones?

Along with making sure the opportunity fund application is filed by the developer, there are some investment restrictions. In most cases, 90 percent of the property, or the assets in that fund, have to be qualifying assets. There are different definitions of qualifying assets, whether it’s an operating business or real estate. (Real estate is a little more restrictive.) Generally, investors need to be improving the property or bringing new business into the area.

Where are the opportunity zones in Northeast Ohio?

Broadly, most of the downtown areas of major cities fall into the opportunity zones. That means much of downtown Cleveland, quite bit of downtown Akron, Youngstown, Warren, etc. But, surprisingly, there are other areas like around Warrensville Heights that also fall into an opportunity zone. For a full listing, including a map broken down by address, visit this opportunity zone resource page from the U.S. Department of the Treasury.

What are some risks to be aware of?

This is a hot topic, but investors need to be careful. They should work with people who know what they’re doing to ensure their investments will actually qualify for the exclusions and deferrals.

In addition, investors shouldn’t overpay or get taken in by high fees. Too often, people are so excited about the tax benefits and deferring the tax, they don’t realize they’re paying too much for the property. Or, if they’re investing through a developer, the developer takes too much for himself — rather than getting 20 percent of the upside, maybe he’s taking 30 percent. So, investors must make sure, overall, it’s a good economic investment.

Insights Accounting is brought to you by Ciuni & Panichi, Inc.

How to ensure you’re getting the most out of your accountant

Accountants are often brought in to a business as an adviser to address issues that are too complex or outside the wheelhouse of the business owner or executives. But not all accountants are created equal.

There are signs business owners should be aware of that indicate an accountant isn’t doing as much as he or she could to help move a business forward. And when those signs become apparent, it’s time to part ways.

Smart Business spoke with Kirk Trowbridge, CPA, director at Clarus Partners, about the signs a relationship with an accountant isn’t working out, how to sever that relationship and what traits to look for in the next accountant.

What should business owners consider as they look to evaluate the work their accountant is doing?

A good place to start is to ask other service providers you currently have a good working relationship with and whose opinion you value if they could recommend an accountant.

For example, you could ask your attorney, banker or financial adviser for a list of potential accountants who they would recommend. You can then setup face-to-face meetings with the accountants on the list and determine if the person has the possibility to be a good fit to work with your organization. You can ask the accountants that you are interviewing for references from clients they currently service. It’s a good idea to ask for references from their clients that are operating in similar businesses in terms of size and industry.

What are some common signs that a relationship with an accountant isn’t working?

If you cannot get your phone calls or emails returned in a timely manner, it is usually a sign that the accountant does not value you as a client.

Another sign is if you ask your accountant questions that are specific to your industry and they are not able to answer the question or at least get you an answer in an acceptable time frame. Not every accountant is going to know the answers to every question on the spot, but they should have the resources and ability to get you an answer.

Once it’s determined that an accountant isn’t right for an organization, how do you suggest the company end the relationship?

It depends on how long of a working relationship you have had with the accountant.

If you have been working together for a long time, a meeting to inform the accountant that your organization no longer fits them is a good idea. It’s not necessary to give a lot of details about why you are making a change. It’s a good idea that you put something in writing informing the accountant that you will no longer need their services as of a certain date. That way there can be no confusion on when the relationship ended.

If you have only been working together for a short period of time, informing the accountant in writing is fine, but putting a date as to when you will no longer need their services is recommended.

How can companies ensure their next accountant is a better fit?

Do your due diligence. Interview more than just one accountant. Ask to meet other people in their firm. Ask to meet the other people that will be working on your account as well. Ask for an engagement in writing that specifies exactly what work the accountant will perform and the expectation of when that work will be completed. Know what the accountant expects of you as well. What information will you provide to them and in what manner? Make sure both sides know and are in agreement as to their role, and what is expected in this relationship.

Using the right accountant can be a big asset to your organization. The right accountant can both provide accurate and timely financial statements and tax returns, and can be a valuable part of your team and assist you in helping your organization be successful.

Insights Accounting is brought to you by Clarus Partners

As the Wayfair decision takes hold, companies need to take action

The U.S. Supreme Court Case, South Dakota v. Wayfair Inc., overturned the physical presence standard for sales tax that had been in place since 1992 in Quill Corp. v. North Dakota, and replaced it with an economic standard.

The guidelines established by South Dakota’s Supreme Court, which are anticipated to be adopted by states across the U.S., require out-of-state retailers to collect and remit sales tax if the retailer has delivered more than $100,000 of goods or services into South Dakota or engaged in more than 200 transactions for the delivery of goods or services to South Dakota. Companies that meet just one of the two guidelines have established nexus for state sales tax purposes. 

Currently, there are more than 30 states that have enacted sales tax legislation similar to South Dakota’s, though Ohio is not among them. It’s expected that most of the remaining states will enact similar statutes. 

Smart Business spoke with Keri Boergert, a principal with Clark Schaefer Hackett CPAs & Advisors, about what businesses will need to do because of the Wayfair decision.

How does a business know whether it needs to comply with the laws coming out of the Wayfair decision? 

Many companies are interested in the case and are reaching out to law and accounting firms to understand the potential impact on their businesses. State and local tax experts can help companies perform an analysis to determine whether additional compliance is needed. 

One of the first steps in determining whether the company faces additional compliance requirements is looking at the amount of sales and the volume of transactions the company has historically had in each state. Most states are following the guidance set forth in Wayfair.  

In Wayfair, the court ensured that the obligation to remit sales tax would not be applied retroactively. Therefore, even though a company might review its sales and transaction footprint historically, the application should be applied prospectively according to each state’s effective date. 

How does this decision affect businesses?

Wayfair is causing significant compliance requirements for businesses that have never even set foot in a state. The number of sales tax returns could increase as more states adopt the new thresholds. This could change a company’s tax filing burden from one home state to dozens of states. 

It’s a much different experience filing in one state versus 25. Every state has different filing requirements — annual, quarterly or monthly. This adds layers of compliance and tracking that might not have previously existed for a company.

Many businesses may not even be equipped to deal with the changes and may have to consider special software that integrates with their accounting system to analyze transactions. Considering an outside state and local expert is the best course of action to provide software guidance and determine when to file. 

What are the consequences of not complying with new laws?

If a company has created sales tax nexus and therefore has a collection and filing responsibility and does not comply, the company will take on the risk for the sales tax liability. As with other state taxes, there is always a risk of examination by state agencies and if examined, the company will not only be liable for any potential tax due, but will also face penalties and interest. Depending on the magnitude of the potential exposure, the sales tax liability could put a business at serious risk. 

What else should businesses know about this decision? 

Online retailers, distributors and remote sellers that traditionally may not have had a physical presence in a state will most likely be impacted. However, other industries, such as manufacturing, may be impacted because of increased collection and retention of exemption certificate responsibilities. 

The move from a physical to an economic presence for sales tax collection is a sweeping change that has the potential to affect many businesses. Now is the time for companies to take a hard look at their business footprint and engage with experts to assess the potential impact.

Insights Accounting is brought to you by Clark Schaefer Hackett

Business entertainment tax deductions are gone: What you need to know

Before the federal tax overhaul, business meals and entertainment were generally deducted at 50 percent. Now, meals remain generally 50 percent deductible. Entertainment does not.

The changes are only to select expenses, but some companies were taking large deductions to entertain clients, which could impact their taxable income.

“This affects everybody from a sole proprietorship to a large multinational company,” says Melissa Knisely, CPA, Tax Department Senior Manager at Ciuni & Panichi, Inc. “We’ve known about the changes and have made clients aware. The recent guidance has enabled us to clarify some of the previous unknowns.”

While this change under the Tax Cuts and Jobs Act (TCJA) was effective Jan. 1, 2018, the IRS recently provided some interim guidance while we wait for proposed regulations.

Smart Business spoke with Knisely about what taxpayers need to consider with the revised meals and entertainment deduction, including interim guidance from the IRS.

What exactly will need to be treated differently and what remains the same?

The two exceptions allowing entertainment to be deductible were repealed as of Jan. 1, 2018. So, all entertainment, amusement or recreation activities are now nondeductible. Theaters, clubs, lounges, tickets for sporting events, skyboxes, transportation to and from sporting events, cover charges, taxes, tips and parking for entertainment events would all be considered part of entertainment, amusement or recreation.

The TCJA clearly addressed entertainment, but meals were not specifically addressed. Recent interim guidance from the IRS did, however, provide some clarity. Business meals can continue to be deducted at 50 percent, provided they meet five qualifications:

1. The expense is an ordinary and necessary business expense paid or incurred during the tax year when carrying on any trade or business.

2. The expense is not lavish or extravagant.

3. The taxpayer, or an employee of the taxpayer, is present when the food or beverages are furnished.

4. The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact.

5. For food and beverages provided during or at an entertainment activity, they are purchased separately from the entertainment, or the cost of the food and beverages are stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

This last point is particularly important. It means if the meal is part of the entertainment, such as a baseball game, taxpayers must pay for the entertainment separately. In cases where the food is included with the ticket to the game, the food would only be deductible if separately stated on the ticket or invoice.

What are companies doing now to comply?

It’s mostly a matter of understanding what’s happening and then making sure it’s being accounted for in such a way that it is easy to determine what is deductible for tax purposes and what is not.

In the past, businesses had one trial balance account for meals and entertainment. Now, they need to review their 2018 activity to ensure that food and beverage is stated separately, while recording invoices to two separate accounts — one to meals, one to entertainment.

How are calendar and fiscal year filers handling this differently?

If you have a business that is a calendar year-end filer, you’ll follow the new rules for the entire 2018 calendar year. If you have a business that follows a fiscal year end, you’ll follow the old rules for the portion of the year that falls in 2017 and you’ll follow the new rules for the portion of the year that falls in 2018.

What else is on the horizon for meals and entertainment deductions?

Currently, there’s a 50 percent deduction for meals for employees’ benefits, such as coffee, doughnuts, overtime meals or occasional group meals, as well as the expenses of an employer-operated eating facility. In 2026, if nothing changes, food at the office won’t be deductible. This will be something companies should keep an eye on.

Insights Accounting is brought to you by Ciuni & Panichi, Inc.

There are many benefits to the newly created Opportunity Zones in Ohio

Established with the Tax Cuts and Jobs Act of 2017, Opportunity Zones are low-income census tracts nominated by governors and certified by the U.S. Treasury that are intended to provide preferential tax treatment for investment.

“Opportunity Zones are built to provide significant tax advantages to investors into stock, businesses or property located in a Qualified Opportunity Zone,” says Graham Allison, CEO and co-founder of Opportunity Zone Development Group, a Clarus Partners associate.

Smart Business spoke with Allison about these innovative federal tax incentives, and how businesses, investors and communities can take full advantage of them.

Who benefits, or at least stands to benefit, from an Opportunity Zone?

Opportunity Zones were made with bipartisan support as an economic development tool to create jobs in emerging markets. They’re designed to attract some of the estimated $5 trillion in unrealized capital gains to these underserved areas. If they perform as expected, neighborhoods will benefit from added investment and job creation, and investors will benefit from significant tax incentives.

For investors, there are the following benefits:

  • Upon sale of an asset, the investor defers the capital gains tax until the sale of the subsequent investment or December 31, 2026, whichever comes first.
  • If the business holds the asset for five years, there is a step up in basis of 10 percent.
  • If the asset is held for seven years, there is an additional step up in basis of 5 percent, before the tax payment becomes due on April 15, 2027. Essentially, an investor pays 85 percent of the original tax due up to eight years later.
  • If the asset were held for at least 10 years, there would be no tax on the appreciation of the asset. While this incentive is like a 1031 Exchange for real estate, it ends the cycle of transfer of assets between like-kind property and allows an investor to realize the entire gain.

Who can invest in an Opportunity Zone and what should investors expect in return?

Investors that can participate include individuals, corporations, businesses, REITs, and estates and trusts that invest through a Qualified Opportunity Fund. A Qualified Opportunity Fund is a partnership or corporation that maintains 90 percent of its assets in a Qualified Opportunity Zone.

Investors can sell a real estate property, business or stock and reinvest it in a Qualified Opportunity Fund to acquire Qualified Opportunity Zone assets. Opportunity Zones enhance returns as investors can utilize funds they would have otherwise paid in capital gains taxes to obtain real estate cash flow, grow a business or gain dividends on stock.

The greatest benefit comes when selling the asset after 10 years as there would be no tax on the appreciation of the Qualified Opportunity Zone asset. That represents a significant tax savings on gains.

Where are the Opportunity Zones in Ohio or where are they expected to be once they’re created?

Ohio has 320 census tracts designed to promote investment in low-income areas. Ohio was permitted to submit up to 25 percent of its eligible census tracts and 73 counties contain these eligible zones. A map of eligible Opportunity Zones can be found at

What should the investor communities know about Opportunity Zones before committing to invest in one?

Investors should talk with their tax professional before committing to an investment in an Opportunity Zone. While the Opportunity Zone incentive is very flexible, it requires strict compliance to ensure it is actualized.

Insights Accounting is brought to you by Clarus Partners

Demystifying Industry 4.0 for business owners and manufacturers

The term Industry 4.0 continues to mystify many business owners, but it’s less complicated than it sounds.

“People think it’s a large, complex and expensive transformation that only big companies can do. That’s not the case at all,” says Eskander Yavar, national leader of Management & Technology Advisory Services at BDO USA, LLP.

While U.S. companies are behind Europe and Asia on this, the wave is starting to break as everything becomes more digitized.

“There could be a point, in the next five to 10 years, where if you’re not doing it, you’re slowly dying,” he says.

Smart Business spoke with Yavar about what Industry 4.0 is, examples of how it has helped companies and how to get started.

What exactly is Industry 4.0?

It refers to the fourth industrial revolution. The first revolution was the advent of steam and water power to drive machinery in factories, which enabled less manual effort in the 18th century. The second revolution was how electricity changed the factory floor, which brought globalization and mass production in the 19th century. The third revolution was the introduction of computers, the internet and automation. This next revolution combines artificial intelligence (AI), data, the cloud — which is just off-site computers — 3D printing, etc.

It’s not a total transformation that’s cost intensive. It’s not reinventing every company. It’s about understanding the technology and the availability of data and connectivity through internet-enabled devices, so new technologies can solve a business problem. For example, you can improve on-time delivery by managing the end-to-end supply chain process through data, an analytics platform, radio-frequency identification tags and sensors.

Industry 4.0, and its ability to deliver data about demand-curves, buying behaviors and other critical patterns and predictions, applies to all manufacturers, from process-oriented and repetitive, to build-to-order. It enables them to gather greater business intelligence and develop customizable products on a mass scale. It accelerates the decision-making process and improves speed to market.

What are some examples of how Industry 4.0 can drive business results?

One manufacturer makes traffic signal preemption hardware so public safety and emergency vehicles can change red lights. It historically wouldn’t come back to customers unless it was time to service or upgrade that hardware. This manufacturer noticed its network threw off data about traffic conditions, how many times a vehicle caught a green light and other metrics. The company took that data and built an analytics platform in the cloud. Then, it sold the data in its desired state for compliance reporting to generate monthly revenue.

In another example, a transportation company had cargo ships going off course during their auto-pilot controlled routes. Because of the anomalies, ships were late and fuel costs rose. The amount of data that needed to be crunched to identify the issue was on such a large scale that the company used an AI algorithm to analyze the data to discover where anomalies were occurring. Then, the company implemented sensors on those ships, so it could autocorrect the errors as they were happening.

How should businesses get started on this?

Do a quick assessment of your technology, processes and connectivity, from a maturity perspective, to ensure the environment is right to introduce something different. Then, look for a use-case — a small proof of concept project — so you can get a quick win with better operational and financial results. Perhaps, it’s tackling a through-put at a certain point on the shop floor by adding sensors and analyzing that data. Then, over time, as you prove out every use case, you end up with larger upside.

Some businesses are already doing this, but don’t call it Industry 4.0. There are a lot of options, too: everything from a fully integrated digitized environment throughout the organization, to systems you don’t have to pay for. However, remember that while it involves technology, data and cloud, it’s not an IT project. It involves change for people and technology. The CIO shouldn’t be driving the transformation; it’s the operations or plant manager who understands inefficiencies in your environment, with executive team support.

Insights Accounting is brought to you by BDO USA, LLP

Budgeting, forecasting for a business and how it impacts personal finances

The personal lives of business owners, especially those with smaller companies, are intertwined with their business as long as it’s in existence. It’s a means of support for family expenses and their lifestyle.

Good budgeting and forecasting for business owners and their companies are critical to achieving the goals of each.

“A lot goes in to budgeting and forecasting, but when the business fiscal year ends, it’s a brand new ball game. Questions need to be answered before it begins,” says Michael Van Himbergen, CFP®, a financial advisor at Skoda Minotti.

“Review your financial situation and the financial situation of your business annually to make sure any obstacles — anticipated or otherwise — are handled before the end of the year so they don’t become roadblocks.”

Smart Business spoke with Van Himbergen about what to include in annual financial reviews and why they’re important.

What are the major considerations business owners should make as they budget and forecast?
Every goal needs a timeline, whether short- or long-term. Consider inflationary factors — the longer the timeline to achieve the goal, the greater the impact of inflation — and establish a target rate of return for each goal.

Make sure you’re paying yourself first out of business revenue. Calculate that as an expense and build it into the budget every year.

Establish a retirement plan for yourself and your employees if you haven’t already. There are a number of factors that determine what type of plan is best to implement, such as the number of employees, their average age, employer and/or employee contributions, to name a few.

If you want to cover college expenses for your children, the longer you wait, the more it costs. Families need to save $500 to $600 per month (per child) from the time their child is born to get them through four years of an in-state public university.

However, take care of yourself first to make sure you’re on track for retirement before funding for a child’s education. Children will have their entire productive lives to pay back student loans. You can always help out down the road.

Also, don’t forget to plan for weddings, big vacations and any other major purchases, accordingly. And it’s always prudent to have three to six months of monthly living expenses to cover an emergency.

How frequently should business owners review their business and personal finances?
Every year. Is your plan doing what it’s supposed to? Review the company 401(k) with employees. Is participation low? If so, determine the reason they’re not participating and educate employees on the benefits of the plan.

Always review income projections. A cash flow analysis will show you whether income is stable or fluctuating.

Review personal investments at least annually unless there are significant changes that would affect longer-term planning. If that’s the case, talk to your financial advisor/accountant to determine how that life-altering event could affect your long-term financial goals.

What, generally, are some ways to adjust to the new financial realities that follow a life-changing event?
Changing jobs, death or disability, death or disability of a partner or a key employee, having children, getting married or divorced are common life-changing events. When these events happen, it’s important to determine how they impact your financial plan.

Any of these can affect cost of living, the level and type of insurance protection that’s prudent, and how much money is available to save and spend. Regardless of what’s happened, it’s important to stick to a financial plan and make adjustments as needed, rather than stop saving altogether.

Unexpected aside, define your goals to determine the level of risk that’s prudent given your situation and the goal you’re trying to obtain. Review your circumstances at least annually with your financial advisor, both in terms of what’s going on in your life and in your finances, and you should have no trouble achieving your goals.

Insights Accounting is brought to you by Skoda Minotti.

Tips on identifying and reporting fraud in your organization

Fraud happens in businesses of all types, sizes and levels of sophistication. Though it can occur at any level of an organization, fraud more frequently happens at the management level or above. A 2014 report by the Association of Certified Fraud Examiners (ACFE) found that 36 percent of those who committed fraud were mid-level managers. Most were male and 87 percent were first-time offenders.

“Upper-level employees are more likely to be entrusted with sensitive information and may be able to override controls,” says J.W.Wilson, CPA, a partner in accounting and auditing services at Clarus Partners. “However, having a profile of a common perpetrator isn’t enough for an organization to stop fraud.”

Smart Business spoke with Wilson about fraud, its effect and what organizations can do to detect and mitigate it.

What are the more common types of fraud and what can they cost an organization?

There are two categories of fraud that are most common: misappropriation of assets and misstatement of financial statements. Asset misappropriation is a scheme through which employees steal or misuse an organization’s resources — for instance, false billing, inflated expense reports or outright theft of company cash. Misappropriation of assets is the most common, but it’s the least costly, averaging around $130,000 per loss.

Financial statement fraud is a scheme through which employees intentionally cause a misstatement or omission of material information in the organization’s financial statements. That could mean recording fictitious revenues, understating expenses or artificially inflating assets. Though financial statement fraud is the least common type of fraud, it’s the most costly, averaging $1 million per loss.

In general, fraud costs businesses in the U.S. billions of dollars each year. Typical acts of fraud costs businesses between $10,000 and $500,000. But in addition to costing businesses money, fraud also hurts productivity and company morale. Fraud can damage the reputation and customer relationships of the business, which can take significant time and energy to repair.

How is fraud typically detected?

Most often fraud is detected by an employee of the organization who then reports the fraud to someone internally.

Because staffers are most likely to identify and report fraud, it’s a good idea to put in place a fraud hotline or reporting system. In making employees aware of the hotline, consider communicating to whistleblowers that they will be protected from any reprisal, and that they could earn a financial reward if they’re willing and able to give useful information to law enforcement.

What are internal control reviews?

An internal control review is an overall assessment of the internal control system and the adequacy of that system to address the risks of the organization. They can highlight weaknesses in a company’s internal control structure or expose processes that could be strengthened to maximize efficiency. Detailed recommendations would be given to help mitigate risk or strengthen areas of identified weakness.

Most often, a company’s board, the owner or CFO requests internal control reviews. But it’s a good idea to perform a review every three to five years or more often if there is significant change in the company.

What should companies do once they have the results of their internal control review?

Management should work to implement the recommendations pulled from the findings of the internal control review and ensure that they are in place. Going forward, management should regularly communicate reminders of policies and procedures to the company, and periodically review the procedures and check that they are consistently being followed.

Research by the ACFE indicates that the typical organization loses 5 percent of revenues each year to fraud. While that 5 percent is certainly a chilling average, consider that the median losses from fraud for businesses with less than 100 employees are around $147,000. A loss of that size could be devastating for a midsize business.

Companies should understand that fraud could happen anywhere. Strong internal control policies and procedures are the best way to help minimize this risk.

Insights Accounting is brought to you by Clarus Partners

Oversight is needed to mitigate occupational fraud

Business owners, board members and other key stakeholders should give more consideration to what their organization is doing to prevent fraud, says Laurie A. Gatten, CPA, CFE, a director at Barnes Wendling CPAs.

“It’s concerning when I begin initial discussions with owners or other key stakeholders regarding internal controls, and when I ask them how they identify risks of fraud and what measures are put into place to mitigate those risks, the answer returned is, ‘That’s why you’re here as our auditor,’” she says.

Smart Business spoke with Gatten about occupational fraud and the internal controls that can mitigate it.

What is occupational fraud and what forms does it typically take?
Occupational fraud is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of an organization’s resources or assets. It can be as simple as theft of company supplies or as complex as sophisticated financial statement fraud or corruption.

Asset misappropriation, corruption, and financial statement fraud are three types of occupational fraud. Asset misappropriation is by far the most common, but the least costly with a median loss of $114,000. The least common type of scheme, but most costly, is financial statement fraud with a median loss of $800,000.

What are the signs that fraud is occurring?
In most cases, fraudsters display at least one behavioral red flag and sometimes they exhibit multiple red flags.

The six most common red flags are:
  Living beyond their means.
  Financial difficulties.
  Unusually close association with vendors or customers.
  Control issues and an unwillingness to share duties.
  Divorce or family problems.
  A ‘wheeler-dealer’ attitude.
The leading detection methods are tips from employees or others, internal audit, and management review and oversight. More than half of all tips are provided by employees, but tips can also come from people outside of the organization, such as customers, vendors, and competitors.

What should happen once fraud is detected?
Once fraud is suspected or determined to have occurred, the perpetrator should be immediately removed from his or her position. The company should consult legal counsel and a certified fraud examiner. The attorney will assist on human resource and other legal matters, while the certified fraud examiner can quantify the losses, present investigation findings, and assist in developing proper controls to deter future fraud.

What steps can companies take to mitigate occupational fraud?
The first step an organization should take is actually implementing a fraud mitigation strategy. It’s really important for everyone to understand that management is responsible for implementing a sound internal control structure. While having an external audit is one way to measure a certain amount of effectiveness of a fraud mitigation strategy, the auditors cannot be part of a company’s internal control structure.

How can an organization test its fraud mitigation strategy to ensure it’s effective?
The best way to test the effectiveness of a fraud mitigation strategy is to have an ongoing monitoring process in place to evaluate it.

There are several measures to incorporate into a monitoring process, but most important are:
  Establishing a third-party hotline where suspicious activity can be reported without reprisal. Ensure all employees are aware it exists and know how to access it.
  Communicating anti-kickback policies to vendors, customers, and other outside parties.
  Jobs rotations, mandatory vacations, and determining if proper segregation of duties is in place.
Everyone in an organization is busy and it is easy to let certain internal controls go by the wayside. Continuous monitoring is key to ensuring the internal controls structure remains strong and is effective.

Insights Accounting is brought to you by Barnes Wendling CPAs