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How to Prevent Fraud in Your Small Business
Most small business owners don’t even consider that their employees might be stealing from them until it’s too late.
The average small business fraud lasts 24 months and costs $200,000 by the time it is discovered according to the 2008 Report to the Nation by the Association of Certified Fraud Examiners (ACFE).
Three former employees of PBS&J, a Miami engineering firm, pleaded guilty in federal court to their roles in embezzling $36 million in a scheme that spanned more than 12 years. (According to a Miami Herald report on September 29, 2006.)
The average American business loses 7% of revenue (sales) to fraud, more than the total profits of many small businesses. There are five main causes of increased incidence of fraud in small businesses.
1. Confidence. Small business owners tend to be closer to their employees, knowing them both personally and from a business standpoint. For an employee to steal from you, you have to trust them. Employees tend to have more confidence in small businesses.
. Little labor. With a small number of employees, many employers believe that controls are impossible. This is not true. Even with a small number of employees, some controls can be implemented. Even a small number of controls can reduce the likelihood of fraud. For example, the ACFE report indicates that companies with a job rotation/mandatory vacation policy had 61% fewer fraud losses.
3. No delegation. Small business owners often want to be in control. As a result, employees are hired, given a job, but the owner keeps important parts of the job for himself. As a result, there seem to be controls. Unfortunately, the owner has been overloaded with too many tasks; and as a result, they do a poor job of executing them. For example, signing checks without thoroughly reviewing the documentation.
4. Overlapping and unclear job responsibilities. In a small business, it often feels like everyone is responsible for everything. If a job needs to be done, everyone is expected to participate. Unfortunately, this provides an opportunity for a rogue person to bypass controls by being able to work in more than one part of the company.
5. Controls are not a priority. Finally, controls don’t seem to be a priority for most small business owners. There is a pervasive “it can’t happen to me” attitude. Unfortunately, it can happen to you! Spending a little money now to install a series of preventative controls should be seen as an investment (not unlike an insurance policy), not an expense. Like insurance, you hope you don’t need it, but if you do, controls can be there to help.
A former Home Depot employee pleaded guilty in federal court in New York to accepting millions of dollars in kickbacks from vendors to ensure the company would stock its products. He shared more than $2.5 million in bribes with other company employees in a scheme that spanned three years. (According to a Reuters report on June 30, 2008.)
1. Recognize the possibility that it could happen to you. Business fraud is widespread and most business owners don’t realize it until it’s too late.
2. Become aware of common fraud indicators. There are many indicators of fraud. Business owners should be aware of these red flags and watch out for them. They don’t always mean that fraud is occurring, but they do mean that increased monitoring may be necessary.
3. Review and strengthen internal controls and take other anti-fraud measures. There are many measures that have proven effective in reducing opportunities for fraud and providing deterrence. The business owner should be aware of the controls and other measures most common for their particular type of business.
4. As the business owner, you take personal responsibility for ongoing monitoring. In a small business, the owner himself must take responsibility for anti-fraud efforts and control. Trusting an employee with this critical task can be a big mistake if that employee turns out to be a fraud. The ACFE Report also shows that the higher a person is in the organization and the longer they work there (ie, the more they are trusted), the more fraud they commit before they are caught.
A 63-year-old man who worked as a nonprofit director of financial services pleaded guilty in federal court to diverting more than $400,000 in incoming checks payable to the nonprofit in a simulated bank account. (According to a report from the Washington Post on September 24, 2008).
Where to get help
Internal audit. If you are a larger company, a first line of defense should be your internal audit department. Under Sarbanes-Oxley, public companies must have an internal audit report directly to a committee of the Board. But even if you’re not a public company, internal audit should report directly to the top. The department with the most incidents of fraud is accounting, so it generally doesn’t make sense to have internal audit within the accounting or finance functions.
Company lawyer. It is important to actively involve the company’s legal counsel in any anti-fraud program or investigation of suspected fraud. If you are a larger company, this should be your corporate advisor. If it’s a smaller business, you need a trusted outside attorney with experience in this area to guide your proactive and reactive actions.
External CPA. Many CPAs have been trained and have experience reviewing controls and recommending improvements. This can be a standalone task or will be done as part of an audit. Remember that accounting controls only focus on the accounting system. Additional types of controls are needed in other areas to effectively reduce opportunities for fraud. It is important to understand that an accounting audit is not designed to find all fraud, nor is it likely to.
Certified Fraud Examiner (CFE). CFEs have specific training and experience in the area of fraud prevention and investigation. They may also have additional training in accounting, law enforcement, or other fields.
If you suspect fraud
When an employer (or manager) suspects that an employee is stealing from the company; the most common reaction is emotional. You’ll probably want to call them into your office, confront them, and fire them. In most cases, this reaction will only cause additional headaches and possible financial losses.
In general, it is best to keep your suspicions to yourself until after you have consulted with qualified professional and legal counsel. There are many possible issues to consider before deciding on a course of action.
Even if the employee actually did steal from you (and we usually don’t know for sure yet), the legal system gives them numerous rights. Get professional help right away to avoid potential liability.
A hospital warehouse supervisor in Spokane, Washington, pleaded guilty in federal court to charging more than $600,000 to his PayPal account by selling stolen hospital supplies on eBay. The fraud continued for more than three years. (According to a report from the Seattle Times on December 21, 2006).
If you’re a business owner, the time to act is now, not after you’ve incurred a big loss. Go back to the four steps in the prevention section of this article and start implementing them now.
Not sure how to do it? The right professional assistance can prove to be a wise investment.
As a final thought, remember that although controls can in some cases deter fraudsters; they can’t stop a determined thief. A robust and continuous monitoring program is critical to detect fraud early, before it turns into significant losses.
Good luck in your business and fraud prevention efforts!
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