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Strong fundamentals are key to accurate financial reporting

October 30, 2023

Contributors: Thomson Reuters

Even in healthy economic times when companies are thriving, business ethics can sometimes fall by the wayside. A volatile economy may increase pressure on employees of every rank to do “whatever it takes” — even if it’s fraudulent or illegal. A company wishing to avoid these pitfalls needs to lay out the ground rules in a written policy and be prepared to enforce them. It also needs to develop strong internal controls, look for poor quality control and evidence of fraud, and be aware of specific potential risks when cutting costs.

There’s an almost infinite number of ways a company can wander off the high road — from workers pilfering office supplies to purchasing managers accepting kickbacks, product developers “borrowing” competitors’ ideas and executives manipulating financial results. Just because a business is struggling doesn’t excuse bad behavior or management’s tacit approval of ethical lapses. Ethical, well-run companies are the ones best positioned to weather uncertain times. Here are some steps you can take to reinforce business fundamentals.

Lay down ground rules

If you’re going to hold your employees to high ethical standards, you must first define those standards, as well as the values (such as teamwork or superior customer service) that define your company. Put these standards and values in writing and communicate them clearly and frequently to your employees, customers, suppliers and other stakeholders. That way, everyone knows what’s expected.

If you don’t already have one, implement an internal controls policy to help prevent and detect fraud. Your CPA can work with you to determine the policies you need based on the type and size of your business. But common cost-effective controls include:

  • Segregation of accounting duties,
  • Multiple authorizations for checks over certain amounts,
  • Mandatory vacation policies, and
  • Background checks for new employees.

Keep in mind that ethical standards are only as strong as your implementation and enforcement of them. Everyone, from mailroom staff to your CFO, must comply with your company’s policies or face disciplinary action.

Cut costs with caution

Even if your business already has well-established codes of conduct, you may find that current circumstances require a new level of vigilance. Quality control, for example, may be one of the first victims of an economic downturn as some businesses turn to cheaper materials and reduce oversight.

There’s nothing wrong with saving money, but to avoid a possible lawsuit or government investigation, it’s essential that cost-cutting initiatives don’t:

  • Endanger the health or safety of your employees or the public,
  • Violate any laws, including labor, product safety and environmental protection,
  • Increase your liability risk, or
  • Violate the terms of any contracts.

Keep in mind that, even if you avoid a legal catastrophe, your customers are likely to notice if you start cutting corners. Also be on the lookout for increased fraud activity, including small schemes such as inflating expense reports or making promises to customers that your company can’t possibly fulfill to land a commission. More damaging are scams in which accounting staff invent vendors or “ghost” employees, or executives manipulate revenue, growth and other financial metrics.

Set an ethical tone at the top

Well-communicated ethics policies and vigilance will help keep your business on the straight and narrow. Most important, though, may be the “tone at the top.” As many studies have found, the most successful companies have leaders who don’t just talk the talk, but also walk the walk.

Sidebar: Are we heading toward a recession?

The timing and severity of recessions can be hard to predict, and hindsight is 20/20. However, economists currently estimate that there’s a 46% chance that the U.S. economy could contract within the next 12 to 18 months, according to Bankrate’s “Third-Quarter Economic Indicator Survey.” That estimate is down from 59% in the second-quarter survey and 64% in the first-quarter survey. Rising energy costs, persistent inflation and recent interest rate hikes are key concerns among economists.

As the cost of borrowing rises, consumers and businesses may shy away from purchasing big-ticket items, such as vehicles, real estate and equipment. In turn, reduced spending could stifle growth and cause the economy to seize up.

Recently, the top concern among CFOs has shifted from the shortage of skilled workers to federal monetary policy, according to the “The CFO Survey” for third quarter of 2023. This survey, which is a collaboration of Duke University’s Fuqua School of Business and the Federal Reserve Banks of Richmond and Atlanta, found that higher interest rates have already curtailed capital and non-capital spending at approximately 40% of companies. However, the survey also reported that CFO optimism concerning their companies’ financial prospects and the overall U.S. economy rose slightly compared to the previous quarter.

One thing is clear as we head into 2024: Uncertainty abounds. Businesses should take proactive measures to reinforce their ethics standards and internal controls to prepare for the worst, while hoping for the best.

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