Large public companies or small private organizations are all under immense pressure to produce results. Wall Street anticipates growth, the C-suite expects annual plans to be accomplished, and owners expect a return on their investment, especially those who have potentially risked their life savings. Following 2 years of pandemic-driven economic turmoil, many organizations, especially small- and medium-sized enterprises (SMEs), are relatively low on optimism and cash. As a result, the incentive to cut corners, including ones requiring questionable ethics, has never been greater. Chief financial officers, known for exhibiting strong professional ethics, need to lead in navigating this difficult period. CFOs must support their CEOs, cross-functional partners, boards, and owners by shining light on the ethical blind spots and helping protect against potentially severe errors in judgment.
Bracing for Heightened Fraud Risk
The Association of Certified Fraud Examiners’ (ACFE) 2020 Report to the Nations found that many fraud risks increase in small businesses (meaning, under 100 employees) than in large businesses. The risk of billing fraud is twice as high, as well as payroll fraud, and check and payment tampering is four times higher.
Unfortunately, a number of SME owners, CEOs, and other leaders play in the gray or are entirely concerned by the ethics of their business practices. However, it is also likely that the higher risk of fraud and unethical business practices is primarily due to a lack of awareness and the unique challenges faced by SMEs.
Ethical Orientation
Finance leaders and their teams are known for their integrity and trust. The establishment of ethical orientation in the classroom and the consolidation of such orientation through joining professional organizations that mandate adherence to their specific ethical codes, such as the IMA Statement of Ethical Professional Practice or the AICPA Code of Professional Conduct. If companies do not adhere to such codes and participate in ongoing ethics training, they will lose their critical certifications. Professional ethics should inherently be a part of your work and must be consistently reinforced in your journey.
For instance, your business partners are usually experts in their respective fields. They drive the operations, from developing business leads and sales to delivering products and services. However, they often neglect to consider the financial aspect of their work, and lack the CFO’s high ethical awareness, especially if not subject to a formal code of conduct within their profession or the company. As such, they may experience moral blind spots or gaps between their intended and true behavioral actions.
Standing Up to Unique Challenges
The management team and other employees play several roles in their respective position, but not necessarily all are within their domains of expertise. The CEO is typically a strong a-type personality and very confident. Given these characteristics, they may not always be open to feedback. The board of directors, when dominated by the CEO, other critical C-suite members, and personal friends, may not provide adequate checks and balances in the decision making process.
Also, theer tends to be minimal internal control in SMEs. Segregation of duties challenges is the norm. Too many policies are undocumented, if they exist at all, which often leads to inconsistent application and favoritism. Vendor and customer relationships may become chummy or overly casual over time. Conflicts of interest may also go unnoticed.
Furthermore, lower pay often exacerbates the difficulty in hiring and retaining highly qualified and experienced talent. Unfortunately, SMEs inherently are against a variety of unique challenges that increase the risk of fraud and unethical business practices.
Tackling the Issue of Ethics
Finance leaders can and should take a leadership role cultivating their company’s ethical competencies and addressing its unique challenges. Doing so as a CFO requires the following actions:
1. Proper delegation of responsibilities: Finance leaders need to analyze roles and responsibilities and then address the highest risk areas. Investing in cross-training can be a good way to address this issue (i.e. cross-training your payroll associate and mandating the back-up to run payroll at least quarterly).
2. Set Firm Organizational Standards: As a leader, you have the power to define the company’s operational approach, values, and standards of conduct, expressing the expectations in value statements, company policies, ethical codes, and communications. Additionally, the CEO, CFO, and other C-suite members must lead by example to ensure consistency between their actions and their expectations.
3. Proper Internal Control: Leaders should establish tighter controls, especially in high-risk areas such as payroll, cash, and customer billings. In order to mitigate check and payment tampering risk, for example, first address delegation of responsibility issues, utilize check logs, leverage the bank’s positive pay controls, and then review account reconciliations.
4. Adhere to a Strict Code of Conduct: In order to substantially increase ethical adherence, you must formally document the organization’s business code of conduct, train employees on how the code translates to real scenarios, and mandate their acknowledgement of understanding and promise to adhere to the code of conduct.
5. Thorough Governance: Designating a board of fraternized coworkers does not exemplify good governance and tends to hurt companies in the long term. Alternatively, you should appoint a board of directors with the expertise and independence to effectively dissent the management, provide oversight, and act as a sounding board, particularly when related subject matter expertise is lacking.
6. Document Your Policies: Policies all require clarity, communication, and consistency. The key policies need to be documented. If formal policies are not in place, first prioritize where to start (i.e., policies regarding delegation of responsibilities, a delegation of authority, travel reimbursement, conflicts of interest, etc.). Following that, refine the policies as necessary as you go along (policies affected by technological advances and the transition to remote/hybrid work should be consistently revisited).
7. Quality Financial Reporting: Given their utmost criticality, financial closings have to be completed accurately and efficiently. Leverage closing checklists. Lock prior periods once the close is done. You should also execute detailed reviews of the financial numbers, including variance analysis. Issue reports quickly and ensure management understands them, including their accountability. Finally, consider investing in a quality FP&A software to audit and create the financial statements rather than relying on manual methods to prepare reviewed financials.
8. Maintaining Vendor and Customer Relationships: It would behoove most CFOs to have multiple touch points for each significant vendor and customer relationship to help evade the proliferation of harmful relationships. Additionally, you should clarify policies relating to the acceptance or giving of gifts from/to such partners. Clearly define conflict of interest policies and mandate disclosure of all pertinent personal relationships.
CFOs are the arbiters of ethical and effective organizational practices. You must address your organization’s potential ethical blind spots, mandate accountability throughout each department in your company, up to and including the CEO, cross-functional partners, and the board.