INFocus: Detecting and preventing fraud in your business

Date: April, 2014 fraud in your business

This article was originally published in the inFocus Spring ’14 Issue.

Where illegitimate opportunity for personal gain exists with a small chance of being caught, there is a higher likelihood that the opportunity will be exploited.

Small and medium-sized businesses (SMBs) are highly susceptible to such opportunities. SMBs make up 32 percent of occupational fraud cases reported in a 2012 survey by the Association of Certified Fraud Examiners (ACFE).
Fraud is not cheap. The ACFE survey also shows that private companies experienced median losses of $200,000 per incident. This loss is in addition to time and energy spent dealing with the fraud once uncovered. Since nearly half of victim organizations do not recover the losses, prevention and early detection is the most cost-effective way to limit fraud.

Understanding the types of fraud is the first step to prevention. External fraud includes theft of customers’ financial information, mobile fraud, and other intentional external ruses. Internal fraud, also known as occupational fraud, includes billing schemes, corruption, and other internal machinations performed for personal gain to the detriment of the business.

Often because of limited resources and/or internal control weaknesses, such as lack of segregation of duties, the fraud risks assumed by SMBs differ from those faced by larger organizations. They frequently include the following:

Billing schemes

As the most common fraud committed in SMBs, it encompasses instances where an employee sets up bogus entities that charge the employer for fabricated services, expenses or personal items.

Cheque tampering

Consist of instances where an employee steals, and/or alters cheques.

Payroll schemes

Occur when an employee with responsibility over payroll adds ghost employees, or claims fictitious overtime.

Skimming scheme

These schemes encompass instances when cash is stolen from the business before it is recorded. An example is the theft of cash payments from customers while manipulating the accounting of receivables and/or sales.

Non-cash fraud

Consist of misuse or theft of non-cash business assets, and can include theft of inventory, proprietary trade secrets, customer lists, etc.

Being proactive about fraud prevention and detection is paramount. Providing ethics training and fraud awareness to employees can significantly reduce losses in organizations of all sizes. Furthermore, the following preventative actions can be taken to lessen the chances of fraud in SMBs:

  • One top-ranking detection method is to implement a fraud-reporting mechanism, which allow employees to report anonymously potential fraudulent activity.
  • Increase perception of proactive fraud detection by making corporate fraud policies highly visible.
  • Retain forensic accountants or risk consultants to review and implement fraud policies and controls.
  • Instill integrity into corporate culture.
  • Increase segregation of record-keeping and cash handling duties.
  • Conduct pre-employment background checks.
  • Pursue an open-door policy to enable communication.
  • Conduct anonymous surveys of employee morale.
  • Watch out for red flags discussed below.

Red flags

As employees gain seniority in the business, especially top management, a degree of caution should be exercised as more reliance and trust is placed on them. Specific red flags act as warning signs and should not be overlooked in lieu of faith in long-term employees. The ACFE fraud survey indicates that although only 25 percent of fraud is committed by employees with more than 10 years tenure, the cost of fraud generally increases with the level of seniority of the perpetrator.

Drastic changes in lifestyle of key employees, including sudden purchases of luxury items, can indicate unusual deviations from known purchasing capabilities. Living beyond their means is an indicator in over one-third of fraud cases reported in the ACFE survey, so do not be quick to dismiss employees deviations as lottery winnings.
Vacations, or lack thereof, is another red flag. Employee reluctance to let someone else cover the position for a short period of time demonstrates excessive control issues that can stem from the employee having something to hide. Be wary if management exhibits such behavior along with long hours spent at the office and reluctance to delegate basic tasks. Dedicated employees help the business prosper, while employees dedicated to covering their tracks stump business growth.

The impact of fraud is not only financial but can also damage reputation, reduce morale and impact relationships with stakeholders that have a vested interest in effective control of the business’ assets.

If you see multiple warning signs exhibited by employees and unusual fluctuations in financial results, take the time to check it out. It may not be fraud, but active vigilance will reduce the risk of getting caught off-guard.

Connect with the Author

Jim Muccilli is a partner in the Valuations | Forensics | Litigation Group at Crowe Soberman. Jim has worked in this field for over 20 years and brings with him a vast knowledge in the areas of business valuation, loss quantification and forensic investigations. He is also a qualified expert witness.

Connect with Jim at: 416.963.7132 or jim.muccilli@crowesoberman.com. http://ca.linkedin.com/in/jimmuccilli

Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article.

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