Business fraud is when people or companies carry out dishonest or illegal activities that result in financial advantages for themselves. Often, their actions appear to be legitimate practices, which is what makes them so hard to uncover.
Small businesses are often particularly hard hit, according to a 2018 report by the Association of Certified Fraud Examiners (ACFE). [quotes]Private companies and small businesses experience a fraud rate of 28 percent and have a median loss of $164,000. [/quotes]
Types of Small Business Fraud
Any business can be the victim of fraud, but small businesses are especially at risk for certain types of fraud. Reasons for this include having fewer resources for checks and balances in their accounting, and the fact that many small business employees handle multiple tasks that have cross-over potential. The most common types of fraud are:
- Payroll fraud,
- Online banking,
- False invoicing,
- Workmen’s compensation,
- Revenue skimming, and
- Travel reimbursement fraud.
[quotes]Companies that have fewer than 100 employees have a fraud rate of 31.8 percent;[/quotes] Those between 100 and 500 employees typically find 29 percent of frauds being committed by an owner or executive, compared with only 16 percent at larger businesses. In larger companies, the most common types of fraud are typically related to procurement, inventory control, and cybercrime.
Good Old Bob…
“Employee thieves normally don't fit the stereotypical career criminal profile. They often are in good standing, have worked with a company on average of four to five years and nine out of 10 of them are first-time offenders…” says ACFE, in another report.
The takeaway: Placing even long-term, trusted employees in positions without proper internal controls is just inviting problems.
Signs of Fraudulent Activity
You don’t have to rely on anonymous tips to catch fraudsters. In most instances, the person committing the fraud is eventually careless and shows one or more signs of the activity. Some things business owners can watch out for and investigate if they see them include:
- Employees living beyond their means;
- Erratic reporting by suppliers, contractors, or internal employees;
- Process laziness, when necessary steps appear to be “ignored”;
- Inconsistencies in the data and reports;
- Restructuring and dumping of “outdated information” by execs;
- Delays in complying with auditor requests; and
- Abnormal or odd behavior by staff or partners.
Exceptional performance can also be an indicator that things aren’t quite right. When the company appears to be doing too well to be true, or a staff person’s work seems to be faultless, that’s a good time to call in your auditors to check.
Preventing Fraud in a Small Business
When it comes to fraud, prevention is definitely better than cure, even though it’s a painful problem for small companies to deal with. Widely accepted methods for preventing fraud include the following.
Segregate Accounting Responsibilities. It’s important in a small company to avoid having one person who handles all account functions, such as receivables, processing, invoice payments, and banking. [quotesright]When you’re in this position, it’s easy for cases of small fraud to go unnoticed. [/quotesright]
The ACFE gives us the example of James, whose father and uncle entrusted him with the accounting duties in their business. He began using his business purchasing card for small personal expenses, which went unnoticed because he also handled payments to the credit card company. He also began paying himself for unserved overtime and unused vacation time. He was able to get away with it because he handled all aspects of the accounting process.
Automate Bill Payments. Putting your regular bills on autopay is a good way to avoid giving employees access to checks and online banking. It will take you a couple of hours to set up all your bills for automatic payment, and have your payables go directly to your account. This eliminates a huge opportunity for fraud as well as keeping your bills paid on the due date, which reduces your risk of default and late payment penalties. Some accounting packages have apps to handle payment automation, which can also help you manage the process.
Institute Strong Internal Controls. Following hard on the heels of segregated accounting duties, strong internal controls are necessary to detect and prevent fraud. These include restricted access to financial data, inventory control, having several people responsible for signing-off expense reimbursements and overtime. It’s also good to have oversight of check-writing functions, and to review payroll regularly to make sure everything is in order.
Protect Financial Information. [quotes]The old days when you could safely provide your bank and other financial details for making direct deposits and payments are long gone.[/quotes] Now, it’s imperative to protect your financial information to avoid identity theft, fraudulent purchases, and other criminal activities. Credit card information is especially sensitive, since cards can now be used online and in stores with such ease.
Separate your business and personal accounts; this protects you against errors and loss of funds on both fronts. It also makes tracking your business expenses easier. Be wary of who you provide credit card information to and use secure online bill payment services like PayPal or Square whenever you can, to reduce the chances of fraud or theft.
Bank Account Scrutiny. With online banking having taken over the business world, it’s easy for company owners to login and check their account activity at random times. This not only helps you spot when paper-based statements might have been tampered with, but it also lets your staff know you check frequently and can help reduce the chances of fraud.
Know Your Team. Far too many small business owners take on partners or high-level employees without doing proper background checks. While nothing is completely foolproof, it does help to know that the other members of your top team don’t have any black marks against them in the past. There’s no reason why you need not enter into a partnership or employment contract with someone who has a murky record, but you should at least do so with full information about it.
For no Regrets: Make your mantra ‘trust but verify’
Whether you’re taking these measures yet or not, if you notice areas where numbers don’t appear to add up or you see any of the signs of fraud listed above, it’s time to act.
An annual audit by a professional auditing firm will help give you peace of mind and will identify potential problem areas, which you can address and eliminate. It is also a strong deterrent to employee fraud as the probability of being caught is far greater. [quotesright]Besides these benefits, having annual audited financials will make obtaining financing or selling your business far simpler and quicker. [/quotesright]
Resources:
https://www.journalofaccountancy.com/newsletters/2018/aug/basic-business-fraud-warning-signs.html
https://www.lohmancompany.com/enewsletter/article/seven-warning-signs-of-fraud/
https://www.entrepreneur.com/article/290551
https://paymentdepot.com/blog/small-business-fraud-scams/
https://www.completecontroller.com/fraud-statistics-every-business-should-know/
https://bentoforbusiness.com/blog/5-fraud-prevention-strategies-small-businesses-budget/
