August 3, 2019
Why Internal Controls Are Critical for Cannabis Companies
Posted by Parnia Pandkhou
Internal controls are processes designed to ensure the reliability of a company’s financial reports, the effectiveness and efficiency of its operations, and its compliance with applicable laws and regulations. They are a must for every organization. But for cannabis companies, they are also a benchmark to establish credibility.
Developing and implementing operational internal controls will help prevent errors and fraud and will result in more accurate measurement of the financial health of the organization. The ability to demonstrate that a documented system of internal controls is being consistently followed will establish credibility for the business in these four key areas: safeguarding assets, ensuring financialstatement reliability, promoting operational efficiency, and encouraging compliance with management’s directives.
The cannabis industry is experiencing explosive growth. Additionally, it is faced with banking issues due to the illegal status of marijuana at the federal level, compliance with complex regulations at federal and state levels, and high overhead. The industry’s unusually high reliance on cash transactions raises fraud and theft risks — among them, skimming, customer collusion and unauthorized spending.
This means that protecting revenues and ultimately profits becomes even more challenging. To mitigate these exposures, you can employ various internal controls, which we will discuss below.
Monitoring of employees with cash access
Even a strong vetting process and thorough background check before hire doesn’t guarantee an employee’s honesty. Typically, staff don’t engage in criminal activities until several years after being on-boarded. You should track employees’ schedules and monitor their behavior to uncover warning signs such as a sudden change in their working hours; strong objections to making procedural changes in transaction processing, inventory or vendor management; and their refusal to take vacations.
Control of cash receipts and payments
Using serially pre-numbered sales slips and conducting weekly audits will uncover missing slips that indicate discrepancies. Comparisons of daily sales and cash receipts will also expose whether cash is being pocketed. Video surveillance and segregation of duties (discussed below) will also reduce the opportunities for skimming.
Limit access to the safe and always make sure it’s locked. A key and combination access log should be used, and keys should be numbered and assigned to designated employees.
Use of serially pre-numbered purchase orders and verification of incoming orders before payment is authorized will help prevent fictitious and unauthorized purchases. Missing documents or gaps in transaction numbers could mean documents are being used for fraudulent transactions. A sudden increase in slow payments may also indicate an employee is stealing money.
If disbursements from the register are necessary, they should be carefully monitored. An unusual increase in customer refunds, voided sales or discounts are all potential indicators of suspicious activity.
Segregation of duties
Segregation of duties and responsibilities is key to internal control and needs to be adopted for operations, custody of assets and accounting. Separation of duties helps ensure that cash-related activities are monitored and cross-checked, and it reduces the chance of collusion between staff and vendors. Importantly, purchasing, receipts of cash and cash payments should all be handled by different employees. The physical handling of cash should be separated from its recording.
If your organization is small, segregation of duties will be difficult to achieve. You will need to adopt compensating controls to ensure that at least two people are responsible for any task.
Having a robust accounting system with an experienced team of accountants and segregation of duties should result in solid recordkeeping. Employees will lose the ability to hide transactions; any backlog in recording them would signal an attempt to delay detection of fraud.
It’s important to invest in your accounting, accounts payable and inventory software and keep it updated. Restrict access to the financial systems. Understand how your system can allow money to be diverted and inventory to be manipulated in order to determine how an employee might be able to commit fraud. Finally, change passwords often.
The ancillary benefit of having a strong accounting system? It facilitates data analysis to detect buying trends, set pricing and mine data, as well as monitor cash activities. It will also organize your data to support and guide you in daily decision-making.
Internal and external audits
Have a yearly audit performed by an outside firm. The external auditor will test your internal controls, locate weaknesses and make suggestions to improve them. You should also conduct unannounced internal audits to uncover malfeasance and determine areas for control improvements.
Internal controls are essential to every business. In the cash-centric cannabis industry, their importance is only heightened. Strong internal controls will contribute to the long-term profitability of your company and help convince investors of your business integrity.
A former CFO and controller, Parnia has over 15 years of public and private accounting experience. She serves clients in a wide range of industries, including retail, entertainment, bioplastics, technology, cannabis and real estate. Taking a comprehensive approach, inclusive of operational aspects, she provides expertise in financial planning and analysis driven by KPIs.