We may be a nearly cashless society, but most businesses still keep a bit of cash on hand to pay for small expenses. Maybe someone bought flowers for the office manager’s birthday, or maybe the foreman needed to put gas in the company truck. For expenses like those, keeping a petty cash fund on hand is easier than forcing employees to put up the cash themselves and get reimbursed by filing an expense report. 

Petty cash is best used for small, occasional expenses, like buying snacks for the office, office supplies, stamps, parking, or birthday cards. This is usually faster than requesting a check from the bookkeeper, and less risky than handing an employee the company credit card. 

Petty cash shouldn’t be used to pay regular operating expenses such as rent or utilities. It shouldn’t be used to give employees an advance on their paychecks. 

But, because petty cash is, well, cash, it’s also risky and can lead to problems ranging from theft to loss of tax deductions. That’s why a best practice is to set up a petty cash management system

What is a petty cash management system?

A petty cash management system establishes protocols for accessing the funds. Instead of just having an unlocked cashbox behind the front counter, a trusted employee should be designated as the custodian. Only the custodian and one or two executives or the business owner should have access to the petty cash fund, which should be kept in a lockbox. Those protocols include specifics on what kinds of expenses are allowable, the maximum amount for reimbursement, the total amount of the fund, and the precise procedures for reimbursements. 

Generally, when an employee needs reimbursement, they provide the custodian with a receipt, and the custodian hands over the cash. The custodian then logs the disbursement with the date, amount, name of the employee, and the purpose. At least once a month, petty cash should be reconciled. Random audits to count the cash and verify legitimate uses of the fund are also a stellar idea. 

What can go wrong with petty cash?

Even though the name implies that petty cash is small, those small expenses can add up, just as grains of sand eventually add up to beaches and sand dunes. The biggest problem with petty cash is that without a robust petty cash management system, you have poor oversight over that money. Lack of oversight can lead to all sorts of problems. Here are examples of the worst things that can happen. 

Theft. Once a $20 bill is in someone’s pocket, it’s impossible to trace it. If that petty cash fund isn’t kept locked up securely, it can be far too tempting for employees to “borrow” just a few dollars here and there. Over time, that “borrowing” can blow up to be thousands of dollars. Even with a robust system in place, choosing the wrong person as custodian can lead to substantial problems, like this city treasurer who stole at least $2,300, or this city employee who may have stolen more than $800,000. Try to avoid appointing a custodian who has known financial pressures. 

Fraud. Employees with financial pressures and who also feel deserving of an occasional extra bonus may exploit cracks in a weak system to commit fraud. Besides outright theft of cash, employees may create fake receipts or request reimbursement for personal expenses, like office supplies and equipment that mysteriously disappear. Stealing from the petty cash fund is just one way that wily employees have found to commit fraud. 

Inappropriate spending. Petty cash expenditures are handled outside the regular system of approvals, so without clear guidelines for permissible types of expenses and allowable amounts, your employees may not be making purchases that make business sense. Treating a client or customer to lunch is OK, but requesting reimbursement for an employee’s night out with their significant other is probably not appropriate. 

Poor records. Because petty cash has no third-party confirmation like an outside bank statement, your records of what the money was spent on are only as good as the custodian’s record-keeping abilities. Some custodians — while being perfectly trustworthy — just aren’t up to the detailed record keeping required. If the custodian isn’t diligent about collecting receipts or logging disbursements, or makes mistakes in recording transactions or giving out change, the monthly reconciliations may show wide variances between the amount of cash that should be in the lockbox and what’s actually there. 

Missing deductions. Inadequate records can lead to loss of deductions on the business tax return, and also result in poor visibility into the true costs of operating your business. Plugging reconciliation discrepancies to Miscellaneous Expense becomes a problem when the balance in that account is one of the biggest items in your P&L. 

Makes accounting harder. Another side effect of poor records is that the month-end close is harder than it needs to be. When someone has to chase people around for missing receipts or re-do error-filled reconciliations or spend time puzzling out the correct journal entry from scraps of paper and cryptic notes, that adds to the stress of getting the books closed. A robust system gives you the information you need, in the format you need, and at the time you need it. 

Prevent small problems from blowing up

My mom always said that an ounce of prevention is worth a pound of cure, and in the case of managing your petty cash, this is absolutely true. Keeping a close watch on petty cash sends the message to your team that you care about the details, and that you expect everyone to behave honorably and with integrity. That attitude of integrity and honesty will also spill over to your whole business and to your relationships with customers, which will help your business thrive. And who doesn’t want a thriving business?