Process Points

Christopher McKittrick Christopher T. McKittrick is the owner of Perspective Business Advisors LLC. He has...more

Controls and Economic Turbulence

Christopher McKittrick July 17th, 2009

Two recent and seemingly unrelated articles intrigued me. One is titled “Detroitosaurus Wrecks” and appeared in the June 6 issue of The Economist. The other was “Fraud Triangle Analytics,” in the July/August issue of Fraud Magazine. How do these two tie together?

“Detroitosaurus Wrecks” addresses the “demise of GM.” The writers observe the following: “GM’s architect, Alfred Sloan, never had Henry Ford’s entrepreneurial or technical genius, but he had organization. He designed his company around the needs of his customers (’a car for every purse and purpose’). The divisional structure he created in the 1920s, with professional managers reporting to a head office through strict financial monitoring, was adopted by other titans of American business … . Although this model was brilliantly designed for domination, when the environment changed it proved disastrously inflexible.”

Among other things, “Fraud Triangle Analytics” states that “the ‘perfect storm’ of fraud is brewing as global economic conditions create increased pressure on earnings while internal controls weaken and staffs are reduced. As bonuses are cut and workloads increase, there also might be an enhanced rationalization to commit fraud.”

Here is how I see these tying together. The lesson of GM is that organizations need flexibility in their business models and in their business processes. Denying rather than accepting that a tsunami is headed your way is not a good choice. And now that we are in the midst of tsunami, or “perfect storm,” we need to keep in mind how important it is to strike a balance between business needs and effective and efficient internal controls. It takes vigilance and commitment to balance strategy, customer service, profitability, risk management, productivity, cost control, and employee empowerment. Inflexible business models and processes combined with cost-cutting that adversely impact internal controls can come back to haunt.

What is going on in your organization? Are your business processes and models flexible? Given the economic climate, are changes in your staffing or in your information systems weakening your internal control environment? Is anyone even thinking about this? Are you considering or using any technologies that might enable better internal controls while allowing flexibility with reduced staff levels?

2 Comments to “Controls and Economic Turbulence”

Rakesh Shukla Says:

July 20th, 2009 at 3:33 pm

In today’s tough economic climate, it’s no surprise that managing risk has become a top priority; especially for CFOs.

In the business world, risk is managed with strong internal controls. In fact, strong internal controls optimize business performance. Here’s another way to think about it — controls are like brakes. Brakes allow you to go faster. If a bike didn’t have brakes, how fast could it really go? Of course, you also have to be willing to use the brakes! Strong internal controls, like brakes, allows a business to put the foot on the accelerator and aggressively reduce costs without increasing risk.

With the unemployment rate at its highest level in over three decades, it is clear that companies are simply trying to survive by cutting expenses and laying off workers. Individuals whose homes are declining in value and whose retirement assets have been wiped out are also trying to survive. Many are becoming desperate. It is not surprising that occupational fraud is increasing. It’s a vicious cycle where losing valuable assets to fraud may push a struggling company perilously close to insolvency which, in turn, increases the risk of fraud.

And fraud is on the uptick.

More here:

http://blog.170systems.com/bid/9726/Father-s-Day-Crash-Managing-Risk-with-AP-Automation
Don Bradshaw Says:

August 6th, 2009 at 2:14 pm

In well run organizations there will always be a constructive tension between operational efficiency and effective internal control. Well functioning controls sometimes enhance operational efficiency but, on balance, they take more time and effort than the “route of least resistance.” Efficiency enhancement usually results from transactions being performed properly the first time. As everyone knows, it takes about ten times longer to clean up the mess than it takes to perform it properly the first time.
I agree there is probably a significant increase in fraud coming. Even in well run organizations there is entropy in a controls system. After an initial SOX implementation effort, focus shifts, processes change. It takes a vigilant crew to ensure controls keep up as things change. Now that staffing at most companies is reduced, vigilance will suffer. People will focus on immediate goals and wait for internal control staff to flag issues once a year. Productivity will take precedence.
Even before SOX there were well run companies with good control systems but global hyper-competition increased pressure for results. That hasn’t gone away. Corporate governance, the best defense against fraud and waste, is tougher than it has ever been.
I believe education has a significant role to play but control expertise is often lacking in academia. Good corporate governance is possible only with the help of managers in all parts of the company who understand the subject of controls and devote energy and resources to the control system. Accounting education puts more emphasis on internal controls, but not enough. Worse, many accounting teachers have no personal experience in control design and maintenance. In other business subjects the gap is generally greater.
The pendulum always swings both ways. In 1933 and 1934, we cleaned up a big financial mess. It was the 1970’s before that system of risk management began to deteriorate. Some of that deterioration was beneficial, i.e., deregulation had many benefits. Somewhere along the line we crossed a line and risk management just about died. Usually government (read congress) was to blame by blocking effective financial regulation in exchange for campaign contributions. That hasn’t gone away either. All told, given the reduced corporate staffing, continued hyper-competition, continued political meddling, and multi-trillions of dollars being thrown at the economy, a fraud and waste tsunami would be unsurprising. Control experts should prepare for full employment when it hits the fan.
Don Bradshaw
Assistant Professor of Accounting and Business Management
Irvine Valley College