Securing Your Supply Chain: How Internal Controls Help Prevent Fraud

Internal controls are a framework to reduce risk and protect assets, which is essential for safe operations in the complex, fast-moving environment of manufacturing and distribution (M&D). While production efficiency and waste reduction are widely valued, governance and fraud prevention are often overlooked. The reality is that prime fraud targets exist across the supply chain — procurement, inventory, shipping and more — without deliberate controls in place.  

A strong internal controls framework requires a robust governance structure, risk management systems and the right control activities. This article summarizes these components and highlights key considerations for implementing them.

Governance: The Framework’s Core

Governance is the system of policies, procedures and oversight mechanisms that guide how an organization operates, makes decisions and manages risk. In the M&D sector, governance is especially critical because it sets the tone at the top, defining roles and responsibilities across complex operations. It ensures that every process — from raw material sourcing to product delivery — aligns with business goals and compliance standards.  

For instance, strong governance may require a strict hierarchy for procurement approvals, preventing unauthorized purchases that could lead to fraud or waste. This structured oversight helps maintain operational integrity, reduces risk and supports smooth, transparent workflows throughout the supply chain.

Risk Management: Identifying What Could Go Wrong

If governance lays the foundation for how the entire system operates, then risk management is the quality control system on the assembly line. Risk management is constantly scanning for defects, weaknesses or disruptions that could impact operations.  

Effective risk management in M&D is like reinforcing a supply chain: each step must be inspected, strengthened and monitored to keep operations running smoothly. Many organizations rely on the three lines of defense model, a layered system of oversight:

• Line One — Frontline Management Teams: This includes warehouse staff, production leaders, shift supervisors and operations managers. They handle daily operations and real-time risks, such as inspecting goods before they advance in the supply chain. 

• Line Two — Compliance, Legal and Enterprise Risk Teams: They act like logistics coordinators and quality controllers, reviewing the flow of operations, flagging irregularities and identifying emerging risks before they escalate. 

• Line Three — Internal Audit Teams: This is an independent checkpoint that verifies the entire process. Like a final inspection station, this line provides objective assurance that the security, efficiency and compliance controls are working. 

Together, these three lines’ integrated defense system helps shield the organization from disruption, error and fraud. 

Control Activities: Determining How to Fix Problems

Control activities answer the question, “How will you fix issues that get discovered?” These activities include segregation of duties, account reconciliations, vendor setup and payment procedures, inventory management, production planning and scheduling, receiving, shipping verification, and compliance and safety measures. 

One of the largest fraud risks in the M&D sector is the misappropriation of assets, particularly inventory theft or misuse. This form of fraud typically occurs when employees exploit weak controls in warehousing, production or purchasing to steal or manipulate inventory for personal gain. Given the high volume of materials and operational complexity, robust safeguards — such as segregation of duties, inventory oversight and fraud detection — are critical. Organizations can mitigate inventory theft or misuse by implementing real-time inventory tracking, conducting regular cycle counts and restricting both system and physical access based on job responsibilities. Additionally, training employees to recognize fraud red flags and fostering a culture of accountability are key elements in preventing asset misappropriation. 

Managing Internal Controls Implementation Challenges

Below are common internal controls implementation challenges and proposed solutions: 

• Resistance to Change: In fast-paced production settings, employees may view internal controls as unnecessary bureaucracy, especially when they affect daily tasks like inventory handling or work order approvals. 
  • Solution: Engage employees early by explaining how internal controls protect jobs, ensure product quality and support long-term success. Involving them in developing and testing new procedures increases buy-in. 

• Limited Segregation of Duties: Small teams or multi-tasking roles on the shop floor may lead to one individual handling multiple steps, such as ordering, receiving and approving materials, raising the risk of undetected fraud or error.
  • Solution: Use compensating controls like supervisory reviews, automated system alerts or rotating duties. Role-based access in ERP systems should restrict permissions to only what’s necessary. 

• Complex, High-Volume Inventory Operations: Managing thousands of raw materials, parts and finished goods makes accurate inventory tracking difficult. Errors or manipulation can go unnoticed.
  • Solution: Implement real-time inventory management systems and barcoding for better visibility. Regular cycle counts and variance analysis help catch discrepancies early.

• Vendor and Procurement Risks: Inconsistent vendor setup and procurement processes can lead to unauthorized purchases, duplicate payments or fraudulent vendors.
  • Solution: Standardize the vendor onboarding process with required documentation, background checks and centralized approval. Limit who can create or modify vendor accounts.

Conclusion 

In M&D, solid internal controls are key to smooth operations and fraud prevention. Organizations can better protect their operations by ensuring clear oversight, managing risks and tightening controls, especially around inventory and purchasing. While challenges like resistance or complex processes can arise, addressing them with teamwork and the right tools helps keep the business strong and secure. 

Sikich is here to help your organization with challenges implementing or strengthening M&D internal controls or with expert support. Our team specializes in developing practical, customized control frameworks that safeguard assets, improve efficiency and reduce risk across your supply chain. Contact Sikich today to learn how our tailored solutions can fortify your internal controls and drive long-term success.