Effective Control in Purchase Stage to Prevent Frauds

A company with many different processes may suffer from lack of control of the management. If there are no control mechanisms in place, then there are chances of frauds which may result in high losses for the company. A manufacturing company has typically a higher susceptibility to fraud as compared to other businesses. This is because it has more number of activities with financial transactions as compared to any other sector.

Being owner of the company you have to be proactive in addressing this problem. The management has to establish effective controls in the systems. Each step of the various processes should have an external control mechanism so that the management can review it and take suitable action if necessary. The purpose of this article is to help you to implement effective controls in your business.

Generally business are divided into following cycles, we call it as business cycles

  • Revenue Cycle
  • Purchase/Expenditure Cycle
  • Payroll Cycle
  • Inventory Cycle
  • Treasury Cycle
  • Fixed Assets Cycle

In a manufacturing company most of the frauds happen in the purchase cycle. This fraud can be in form of buying material at higher rates or buying of substandard raw materials. Both these frauds could result in losses either in terms of higher expenses or loss of customers due to defective products in the market.

Let’s look at the purchase cycle in detail.

Purchase Cycle can be divided into Pre Order Stage & Post Order Stage. Pre-order stage ends with finalization of vendor/supplier and Post Order Stage starts from placing of order and end at payment.

Each stage will have following activities.

Pre-order Stage Activity

  • Identifying the vendors/suppliers
  • Collecting Quotations
  • Shortlisting Quotations
  • Vendor selection committee
  • Finalizing the Vendor

(Note: Vendor selection activity should be once in a year and cannot be done for small purchases)

Post Order Stage Activity

  • Requirement request
  • Raising Purchase Order
  • Receipt of items
  • Quality/Quantity verification check
  • Approval of Bills
  • Statutory Compliance
  • Payment

The management has to establish effective control mechanisms for all the stages. To establish the control mechanism the management has to identify the different activities that take place in the process.

After identifying each activity one has to see what can go wrong in each activity? The management has to identify the possible scope for fraud or mistake in each activity and design standard operating procedures so that scope of fraud can be reduced.

An example of the standard operating procedure could be having requirement of multiple quotation for any expense item above a certain threshold. Another SOP could be having a standard vendor rate card and automatic alert to the management if there is any deviation in the agreed rate with the vendor.