John (00:01): Hello and welcome to another episode of the Duct Tape Marketing Podcast. This is John Jantsch, and my guest today is Todd Rammler. He's the president and founder of Michigan CFO Associates Affirm offering outsourced chief financial officer services to small business owners. He's also the author of a book 30 Day Total Business Makeover, and we're going to talk about a fun and exciting topic today, embezzlement in small business. Again, not so fun, but certainly essential. Todd, welcome to the show.

Todd (00:34): Thanks so much for having me, John.

John (00:36): So particularly if I think if somebody's been embezzled, they probably know a lot about this topic, but if this never really happened to you, you might be thinking, well, what are some of the ways that particularly small businesses commonly get embezzled? What have you seen?

Todd (00:52): Yeah, the most common way is something to do with billings or collections generally. So fake invoices or collections, like setting up the fraudster will set up a company name similar to a customer name, and then collect those checks and deposit them into their own account. So there's a lot of different ways, but they tend to be creating false documents or creating a company and bringing in company property into their own personal accounts.

John (01:24): It was my personal physician that had one of these separate clinic practices outside of a hospital, and he just turned everything over to the person that was doing the books and turns out she was creating all these credit cards and then charging things on these credit cards and then just ignoring to pay them and eventually went down the road four or $500,000 later. So is it typically, I mean, is that a really common thing that it's somebody inside the business that you've just handed the keys to?

Todd (01:54): Absolutely. It tends to be relationships that have been trusted for a long period of time, and for whatever reason that person feels a perceived need or injustice or something, and then it's a slippery slope. They take one step, get away with it, take a bigger step, and the next thing you know it's going on for 12 months.

John (02:14): So I'm sure a lot of practices you have, here's our set of guardrails. I mean, what are some of the common things that you should do or maybe the opposite of that should never do?

Todd (02:24): Yeah, the number one thing I tell people, we're dealing with small businesses. So the playbook says segregation of duties don't have the same person creating vendors and then approving purchase orders or sending invoices and collecting money. But it's difficult in a small business to do that segregation effectively, whereas in a large company, you have a bunch of different people. So the number one thing I tell people is get employee dishonesty insurance as your stop gap. A lot of companies don't have that, right? And so that's like after the embezzlement occurred, if you have that coverage to be protected, that's the first thing I would do. Well,

John (03:04): Can I go there? Because as somebody who's been in business forever, I've never even heard of that. So is that just you call up your property casualty person and say, I need this kind of insurance?

Todd (03:13): Absolutely, yeah. And then they will ask you how much coverage you want, and there's ways to estimate that. What's the likely amount of embezzlement or fraud that might take place? I can tell you statistically in companies under a hundred employees, that number is the median is 150,000. So you probably don't need millions of dollars of this coverage, and it's not super expensive, but shockingly, many companies don't have it. And that's the number one thing I would do for protection. In terms of prevention, we go back to segregation of duties and not having the same people do where these weaknesses doing the same things. But another very effective tool is presenting yourself as paying attention even if you're not really paying attention,

John (04:00): Because

Todd (04:00): If people think that you're looking and poking around, they're much less likely to take that risk. But in a lot of small companies, the owner or the leadership team may have a very loosey goosey attitude towards it, and then that opportunity becomes more likely to be acted upon.

John (04:19): And again, if you're the business owner, sometimes you have to make hard decisions. But do you find that sometimes business owners struggle with, Hey, if I put all these internal controls in place, like nobody thinks I trust them, is that an issue or it really can it be spun in a different way?

Todd (04:34): Yeah, I mean, I think it is an issue, but we start with what Ronald Reagan used to say, trust but verify.

John (04:40): Right? I hear that actually a lot of people have claimed who have said that, but go ahead.

Todd (04:45): Yeah, he was one. So the truth is it's difficult, but as I said, putting stringent controls in a small company is difficult, but if you set the expectation on the front of this is how we're going to operate, we expect transparency, and I'm going to be checking things, and if not me as the owner, maybe it's your CPA, maybe it's your fractional CFO like us, but somebody is going to have some oversight and be poking around. And even back in the old days when we used to write paper checks all the time, typically the owner would get a stack of checks to write every week or two weeks, whatever the cycle was, and a little bit of background or supporting documentation. But if you start asking questions about that, even if you already know the answer to the question, it gives the impression

John (05:31): That

Todd (05:31): You're paying attention and someone's going to be less likely to go down that slippery slope of embezzlement.

John (05:40): So you hit on two things that I want to come back to. One is you should have an outside, I mean, obviously there are a lot of people that hire CPA, but they really just say, here's my stuff for the taxes in a lot of cases. So you should actually have somebody who is routinely whether call it the fractional CFO model, I love because I think there are a lot of businesses that need CFO base at some point or oversight at some point, but maybe obviously can't afford to hire that role or does it make sense for them to hire that role? But are you suggesting that's a stop gap measure? If somebody from the outside is coming in and looking at stuff maybe once a month, that's obviously going to discourage folks from thinking they can get away with stuff.

Todd (06:22): For sure. And I think it's even a greater resource because that person really understands the behind the scenes accounting of what happens in the accounting system. And so typically owners are busy, they look at the p and l, but they don't look at the balance sheet or they don't look at a cashflow statement. And when you know how those three documents interact with each other, it becomes more apparent when something is out of whack or something needs investigation. And if you're running a hundred miles an hour and you're just top line, bottom line, it's really hard to catch it if you're not in the weeds.

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(08:03): Now, this offer is limited to new active campaign customers only. So what are you waiting for? Fuel your growth, boost revenue and save precious time by upgrading to active campaign today. Yeah, so the second part, and again, I've been doing this long enough that I had my checks with the carbon and I wrote that check and sent it off, and that was a record, and then I'd reconcile that against the bank statement, which actually also had the checks in it. That came back to me. What role has technology played in maybe providing security and maybe opening up holes?

Todd (08:37): Yeah, so I told you my number one safeguard is the insurance policy. The second is using your bank's treasury management functions, and typically something like positive pay, for example, where you tell the bank only authorize these transactions. You can't just write a check to a random name because it won't go through the bank. It is a little more tedious, but it is very effective at eliminating some of these random withdrawals of cash. And then the other thing which gets more into cybersecurity is somebody spoofs your email address or your company URL and then sends invoices to your customers. And that's a little harder. That requires IT security and two-factor authentication and that sort of stuff, which is beyond my scope here, but it is a changing environment for sure.

John (09:27): Yeah, I mean, we focus mostly on internal employee embezzlement, but you're right, I mean there's lots of silly things like trying to hack your website. I mean, we have security on our website several hundred times a day people try to hack into our website. So that has really, and obviously that can cause financial disaster for an organization. So is that, you just said it's outside of what you do, but is that in the realm of risk management, so to speak, of finances? Is that a piece that you should be seeking outside? Not wait till it happens, but have somebody who's actually making things a little hardened before disaster strikes?

Todd (10:07): Yeah, I mean a hundred percent transparency that happened to us. We had somebody spoof an email address, get into our system, and then email a customer with an address that looked like ours, but it wasn't. And the customer wired them a large amount of money and it's gone. You can't get that back. So it's just like embezzlement where you start finding the solutions after you've been a victim of it. Right.

John (10:31): Yeah,

Todd (10:32): And I think trying, one of the things we preach in embezzlement is map out all of the ways money comes in and all the ways money goes out and find those weak spots and build security around them and protections around them. But a lot of times you don't know until it happens to you where that weakness is because we're not very preventative in our approach a lot of times,

John (10:54): Again, I guess because I've been online so long, I've seen a lot of the scams and spoofs and things that come through, and I will say that they're getting on top of trying to prey on people maybe that don't have their guard up. They're getting super sophisticated, being able to make it certainly look like it came from Chase Bank or whoever they're trying to fool. And of course they've got the ability to anonymously send out millions of these, so they only need a couple to hit. So it's pretty scary.

Todd (11:25): It is.

John (11:27): Talk a little bit about the fractional CFO role if you would. Obviously this is, I'm guessing a part of it that you would provide as a service, but what's a typical, if I'm a small business owner and I'm thinking, well, I've got my bookkeeper and I send my taxes off once a year or once a quarter or whatever it is to the person that does those for me, what would looking at a fractional CFO role, what would you gain by that? Would as the provider of those services come in and say, here's the first things we're going to do and then we're going to do this and then we're going to do this. I'd just love to hear how that would work for the small business who maybe has never hired to see anything.

Todd (12:05): Yeah, so the difference is most people are very familiar with that CPA relationship and their role traditionally and typically is compliance. So it's compliance with IRS tax regulation or generally accepted accounting practices gap.

John (12:20): I call it the rear view mirror. Here's what

Todd (12:22): Happens. And it is, yeah, right. So a CFO is going to be focused on what we refer to as managerial accounting, which is how do we make money? What things make us more money or less money, protection of assets, planning for cash, really empowering management to make better financial decisions. And that is a different subset of accounting. I think a lot of people think of accountants and they think of their CPA, but half the accounting population is managerial accountants. So really it's adding that element of, if I was in your shoes as the owner, what financial data and reporting would I want to see in order to make better financial decisions? And that's really what being ACFO is all about, looking forward using history to look forward and plan for wherever that organization is trying to go.

John (13:16): What do you say to the, because I run across this a lot of times. I mean, in some ways this is financial strategy and I do marketing strategy all the time, and a lot of business owners are like, I don't need stretch, I just need more customers. And I'm sure you run across sometimes people that would have that similar view of, I just send out invoices, my customers pay, I pay my bills. What do I need to be analyzing that I'm missing here?

Todd (13:40): Well, as businesses grow, they get more complicated. And so we have a lot of experience with companies who have called us after the fact. Let's say they went from 5 million in revenue to 10 million in revenue or whatever the leap is,

John (13:52): But

Todd (13:53): They made the same or less money for all of that revenue growth or profitability did not grow in step. And it's because we have a mentality versus a health and growth mentality. So there's not a lot of value in growing quickly if you're not going to do that in a healthy way. And in fact it can be much more risky now you have more activity, more employees, more inventory, more dollars tied up, and you're not generating the same return on those dollars.

John (14:23): Talk about the small business owner relationship with profit. I sometimes find it to be sort of odd. I mean that it's a bad thing or that it's not focused on at all. It's like that's the money left over after everything else happened. How do you take a proactive, or maybe you agree with that approach, but how do you take a proactive approach to showing people, no, you should be showing 2015 whatever percent profit, and that's by focusing on that is how you make it happen.

Todd (14:52): So we spend a lot of time talking about what is an appropriate hurdle in terms of percentage, and we can do it either way depending on the situation. Many companies, small companies today are what we call a pass-through entity at S-Corp or an LLC. So we look at that profitability number and we think, oh, well 5%, that's not so bad, but 5% you still have to pay taxes.

John (15:15): You still

Todd (15:15): Have to do capital reinvestment to keep your machinery or your equipment, your office equipment up to snuff, and then any kind of growth investment, and that eats up your 5% and then some. So there's definitely a focus on becoming healthy, as I alluded to in the other question first, and then focusing on growth. And I've had many clients over the years who have been doing record sales and still not making any money, and they just keep saying, well, maybe next year, next year we just need to grow a little bit more, but we've been in business for 20 years and we're still not generating that return. And when you think of it as a return,

John (15:53): It

Todd (15:54): Puts it in context of, if I took this money and I put it in the stock market, what's the return I would get versus I have it tied up in this company,

John (16:01): I invested my life and the return is not much. I tell you where I see a lot of businesses and I don't get into finance at all, but marketing certainly does touch that and the ability to grow, which a lot of people come to us for. And that's the idea of understanding labor and productivity costs when somebody particularly as fulfilling a service as a business, do you have any advice on how you should be, I see a lot of people that's payroll as opposed to measuring some sort of unit of productivity. I know we could go down a really deep rabbit hole here, but what are some just basic advice and guidelines for that?

Todd (16:40): So I would say we tend to look at things in a variable cost environment for assessing profitability at a gross profit level, let's say in the service industry. So if we do more sales, then we would expect to make more dollars of income, but a similar percentage.

John (16:58): And

Todd (16:58): When we see that percentage going down or going up, well, either way it should trigger some questions. And the ways that you can measure that are through it really depends on the type of specific business, but staff utilization is one, what open capacity do we have amongst the staff? What's the sales pipeline look like? But I think paying attention to that contribution margin or gross margin on a monthly basis is the first step in sort of deciding are we hitting the numbers that we're supposed to? And that begs the question of what's supposed to, we need to have a budget or a forecast or a plan that says if we hit the numbers, we are expected to in sales. Here's the gross profit or gross margin we're expecting. And if we don't have that, then we're just being swept around by the wind.

John (17:47): If somebody wanted to hire, and it's all relative, I'm sure, but let's say it's that million to $5 million business that really is just starting to realize, I kind of need some help here, and they wanted to hire somebody like you, a fractional CMO, what's the typical engagement look like? And again, maybe there's a range, but just for somebody who's listening that might, what could they expect in terms of the engagement to look like, the engagement to cost, the weekly monthly meetings, what does a typical engagement look like?

Todd (18:18): So in any engagement, there's a little heavier lifting on the front end for companies

John (18:22): That don't have, you've got to find all the varied bodies,

Todd (18:25): So that may take two months to six months depending. And then we go into what internally we refer to as more of a maintenance mode where we're producing financial statements, we're sitting down with the leadership team and going through 'em. We are tracking against the budget and making the necessary adjustments for cash planning, profit, et cetera. We tend to view engagements in two, four buckets, really one or two days a week or one or two days a month. And so at that size that you described under 5 million, the first three to six months might be once a week, and then after that it might be twice a month, possibly even once a month. But the key to the relationship and the value is having the CFO regularly engaged so that they understand what makes this business tick and can use their experience and analytical ability to help make those better financial decisions. And if you're just checking in once a quarter or once every six months, really you're looking only at numbers and not operations and what's actually happening in the business. So for us, we like to have some kind of a regular cadence so that we can add that value of knowing what's going to make, move the needle for that company.

John (19:41): Well, Todd, this was awesome. Hopefully some people, at least, obviously we didn't have enough time to dig too deep, but at least got some ideas on maybe what they're not doing that have frightened them enough. So I appreciate you stopping by the podcast, but you want to invite people where they might connect and find out about the Michigan CFO Associates?

Todd (20:01): Yeah, sure. The website's Michigancfo.com, and we were talking about segregation of duties earlier. We have a free worksheet if anybody wants it. You can just Google Michigan CFO segregation of duties and it'll pop right up. I don't know the exact URL, but that's a free tool for embezzlement and embezzlement planning.

John (20:21): Great. Well, if you think about it, when we get off this and you want to send me the URL, we'll put it in our show notes too to make it easier for people to find. So again, appreciate you stopping by and hopefully we'll run into you one of these days out there on the road. Todd,