By: Michael Blevins, CFE
Restaurants, like any business, need robust internal controls to ensure the quality of goods and services, maximize profits, and mitigate fraud and theft. Effective internal controls are particularly vital for restaurants due to the industry's unique characteristics, including frequent cash transactions, high daily transaction volumes, numerous employees handling cash, and rapid employee turnover. These factors complicate the establishment and enforcement of internal controls.
The Fraud Triangle
Preventing fraud and embezzlement is a primary focus of internal control systems in restaurants. According to the Fraud Triangle theory, three conditions are necessary for fraud to occur:
Need: Economic or psychological deficiencies driving individuals to steal.
Opportunity: Lapses in fraud prevention enabling dishonest actions.
Rationalization: Justifying the act of theft.
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Key Areas of Internal Control
Cash Handling
Cash theft is a prevalent and challenging issue in restaurants. It can happen before transactions are recorded or after, but before deposits are made. To prevent cash theft, restaurants should:
Limit and know check signers.
Reconcile bank accounts monthly and review reconciliations.
Segregate accounting functions, such as separating cash management from disbursement documentation.
Compare daily deposit reports with bank deposit records and point-of-sale (POS) reports.
Inventory Management
Food and beverage theft is a significant problem due to their portability and universal usage. Internal controls should include:
Independent physical inventory checks compared to book inventory.
Use of pre-printed inventory forms, orderly item arrangements, and dual-person inventory counts.
Investigating and approving significant inventory discrepancies.
Restricting inventory access and securing stock in locked facilities.
Payroll
Payroll is the largest expense for most restaurants, making internal controls in this area critical. Restaurants should:
Segregate responsibilities, such as authorizing employment and wage rates, maintaining the payroll system, generating checks, and reconciling payroll bank accounts.
Routinely examine payroll records, including employees' names, authorized gross pay, hours worked, deductions, and net pay by an independent authority.
Accounts Payable
Internal controls in accounts payable are crucial to prevent fictitious vendor creation and cash misappropriation. Restaurants should:
Establish control over received vendor invoices.
Compare vendor invoices with receiving reports and purchase orders.
Cancel all vouchers, invoices, and supporting documents when paid.
Restrict new vendor setups and segregate duties among payroll personnel.
Financial Controls
Financial controls involve reviewing financial statements and leveraging technology, such as POS systems and financial accounting software. Effective measures include:
Limiting POS system access and functions to specific employees.
Creating rigorous cash and credit card tracking systems.
Monitoring and analyzing income statements and balance sheets to avoid unexpected adjustments.
Routinely inputting sales, invoices, and payroll records, and reconciling all balance sheet accounts.
Using financial statements to monitor weekly and monthly results promptly.
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Case Study: The Importance of Robust Internal Controls
A study by the Association of Certified Fraud Examiners (ACFE) found that the average loss per fraud incident in the hospitality industry was $62,000. In one notable case, a restaurant in Chicago discovered a long-time employee had embezzled $300,000 over several years due to weak internal controls. The employee manipulated payroll records and created fictitious vendors to divert funds. Implementing stricter controls, such as segregation of duties and regular audits, could have prevented this fraud.
Conclusion
Restaurants' susceptibility to theft necessitates robust internal controls. By scrutinizing every operational function and establishing comprehensive internal controls, restaurant owners can effectively mitigate fraud and embezzlement risks. Investing in these systems builds a solid financial foundation and enhances the likelihood of detecting and preventing fraudulent activities.
Michael Blevins is a Certified Fraud Examiner and the founder of Blevins Associates Consulting. Blevins Associates Consulting specializes in fraud within the restaurant industry. Michael can be reached at Michael@BlevinsAssociates.com or by phone at 760-206-3717.
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