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    Internal Occupational Fraud: A warning for small business owners.
    The Vault

    Internal Occupational Fraud: A warning for small business owners.

    April 2018

    Internal occupational fraud -- employees who misappropriate assets, tamper with checks, steal cash or inventory, etc. -- robs staggering amounts of money from businesses worldwide each year, with smaller organizations being particularly hard it. This week, the Association of Certified Fraud Examiners released its findings on the state of fraud, and the results should serve as a wake-up call for anyone running a business.

    The association’s biennial report looked at nearly 2,700 cases of occupational fraud at companies around the globe. The most common forms of fraud found were embezzlement, payroll fraud, and reporting false expenses. All told, these crimes cost affected businesses a whopping $7 billion.

    But, here’s the truly stunning thing: Businesses with fewer than 100 employees suffered a median loss of $200,000, nearly double the median loss ($104,000) reported for larger companies with 100+ employees.

    Small business owners, do we have your attention?

    Fraud is a particularly tough problem for smaller businesses because they have far fewer resources than do big corporations to combat the issue. For example, big corporations routinely have hotlines in place where employees can call in fraud tips. Early detection of fraud is critical to saving money, but the report reveals that small businesses were less than half as likely as their larger counterparts to have a hotline in place. As a result, only 29% of frauds at small businesses were detected by a tip, compared to 44% at large businesses. Overall, lack of controls accounted for 42% of frauds at small businesses compared to 25% at larger ones. Lack of controls is THE issue for small businesses.

    Some additional staggering (and depressing) findings for small businesses:

    • An owner or executive committed nearly 29% of frauds at small businesses, compared with 16% at larger businesses. That’s particularly bad because frauds perpetrated by owners or executives produced median losses of $850,000.
    • Some frauds occurred much more frequently at small businesses. For example, check and payment tampering was nearly three times more likely at a small business than a larger one (22% to 8%). Other frauds much more common at small businesses included skimming (20% vs. 8%) and payroll (13% to 5%).
    • Of the 18 internal controls studied in the report, data monitoring/analysis and surprise audits resulted in some of the largest reductions in fraud loss and duration, but only 37% of organizations employed those controls.

    So what can a small business owner do? Lack of resources for sophisticated controls is an issue that’s not going anywhere, but that certainly doesn’t mean that all hope is lost. Here’s what we recommend most often to our small business clients:

    Be aware.

    It sounds trite, but being aware of certain behavioral red flags is step number one. Variations exist depending on the employee’s position in the company and their gender, but be on the lookout specifically for employees experiencing financial difficulties, those living beyond their means, those who are unusually close with a customer or vendor, those experiencing marital or family problems, and those with a “wheeler dealer” attitude. Those qualities are your first clue that something is off.

    Invest in some form(s) of fraud prevention.

    Yes, this means you will have to spend some money, but isn’t spending a little upfront worth the time, hassle, and overwhelming expense later on? We certainly think so.

    • Check references and run background checks. Be certain to ask the most critical question about a potential new hire: “Is this person eligible for rehire at your company?”
    • Develop a written code of conduct that explicitly prohibits fraud, conflicts of interest, kickbacks, and other illegal acts. Require all employees to annually confirm compliance with it, and provide all major vendors and customers a copy of it. Never ever ignore enforcing the code.
    • Carry adequate fidelity insurance to limit your company’s exposure to fraud losses.
    • Ensure that no employees or vendors are added to the payroll or approved vendor list without your approval. Periodically review those lists to ensure nothing has been added without your knowledge.
    • When an employee leaves the company, disable access codes and passwords immediately on software, networks, email, laptops, hard drives, banking information (if they had access to that), and even online subscriptions. Do not leave your technology vulnerable.
    • Personally approve large credit memos, price concessions, and bad debt write-offs.
    • Have customers mail payments directly to a lock-box maintained by your bank or to a P.O. box that you maintain.
    • Require that the person in charge of receiving the mail deliver all bank and credit card statements to you unopened. Personally review them for irregularities and unexpected dips in cash reserves or credit lines.
    • Periodically reconcile daily cash receipts logged to individual customer accounts as well as the amount deposited per the bank statement.
    • Examine all original invoices and receiving documents (do not accept copies) when signing checks to ensure that the prices are reasonable, that goods were actually received, and that the vendor is legitimate.
    • Reconsider the use of a signature stamp for check signing.
    • Require that the bank obtain your authorization for all electronic fund transfers.
    • Notify your bank that the employee who makes the daily bank deposit is not authorized to receive “cash back” from your deposit.
    • Have supervisors review employee time daily to ensure time worked was reported accurately.
    • Require that key accounting personnel take a vacation at least annually. Someone should perform their job function in the interim to detect possible irregularities.
    • Keep an eye on your physical inventory and investigate unusual disappearances.

    Enlist the help of your CPA (you knew we’d say that).

    • Cash disbursements and receipts should be reviewed in detail by a CPA at least once a year to ensure all recorded transactions are supported.
    • Monthly bank reconciliations should be reviewed periodically by a CPA to ensure their appropriateness.
    • Have a CPA review the payroll function at least annually to ensure that pay rates are consistent with each employee’s personnel file and that hours paid reconcile with manual timecards or time sheets.
    • Have your company’s financial statements audited annually by a CPA. The cost of fraud losses is 35% lower in companies that have an internal or external audit.

    Set a good example.

    Owners who dip into petty cash, fudge expense reports, or “loosely” conduct business will soon find that employees do the same. Set an ethical example for employees to follow.


    Fraud is expensive, plain and simple, and it hits small businesses particularly hard. Don’t leave yourself vulnerable. Remember, we’re here to help.

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