Fraud in Small Business

A Publication from Alan D. Lasko & Associates, P.C.                                           

Billion dollar frauds at large companies may dominate the headlines, but occupational fraud actually takes a bigger toll on small businesses. Statistically, small businesses are more likely to experience occupational fraud, and when it does happen, they are hit harder.

According to the 2016 Occupational Fraud and Abuse Report from the Association of Certified Fraud Examiners ("ACFE"), organi-zations with fewer than 100 employees were the most common victims of fraud. Small businesses accounted for the largest amount of cases of fraud in the study representing about 30%, while large organizations with more than 10,000 employees accounted for far less cases at 20.5%.

Surprisingly, when fraud occurs, small businesses do not tend to lose smaller amounts of money. According to the ACFE study, the median loss suffered by small organizations was the same as that incurred by the larger organizations – around $150,000 per occurrence.

Many large businesses can absorb a loss of $150,000, but for a small business, that kind of loss is devastating. One instance of fraud can mean that innocent employees lose their jobs or personal investments; creditors may be less likely to extend credit to the company; or worse yet, a company may need years to overcome the "collateral damage" to its brand or reputation, as well as the negative impact to employee morale caused by a fraud situation.

Why Fraud Happens

So why are small businesses more vulnerable to fraud? Often, it's a matter of misplaced trust.

By definition, a small business operates with a smaller staff. The business owner often places more trust, by necessity, in his or her employees to handle daily operational tasks, as well as accounting functions. Many owners do not realize that fraud can be instigated by their most trusted employees, or may have an attitude of "it can't happen to us."

In many cases, the perpetrator is a long-time employee, who has gained the trust of the owner over a period of years. The owner is lulled into thinking that this employee would never resort to fraud. However, the ACFE study notes, "As most anti-fraud professionals know, trust is not an internal control. In fact, trust in the wrong person can lead to disaster."

Keep in mind that, in some instances of small business fraud, the employee was initially honest and may have truly "deserved" the owner's trust. But then the employee experienced a financial setback – a big medical bill, a large debt or a costly addiction – and the combination of desperation and opportunity was too tempting. Or a conflict led the employee to feel mistreated or underappreciated, and thus entitled to steal.

Another source of vulnerability is a lack of basic internal accounting controls.  Most small businesses do not have the resources, or knowledge, to develop the kinds of systems and financial controls that large businesses do.  Most small operations have small accounting departments – often just one person – if any.  They do not have regular audits, and they do not employ a professional trained to implement sophisticated internal accounting controls.

Also, many small businesses operate on tight margins.  Owners and staff tend to focus on making and marketing the product or service that drives company profits.  Taking steps to maintain good financial controls falls by the wayside.

Common Types of Fraud

So what can businesses do? Limited resources are a reality for most small businesses.  But small business owners can understand how fraudsters typically operate, and take some basic, inexpensive actions to minimize risk.

Fraud can take many different forms, but there are some common types that tend to occur in small businesses.  The ACFE study identified these types of fraud as occurring twice as frequently in small businesses compared to larger organizations:

Check Tampering:  The employee (or other fraudster) alters, forges, or steals checks in order to divert funds for his or her personal use.

Skimming:  Also known as "off book fraud," skimming involves an employee or an associate removing cash from the business before it is recorded in the company's accounts.

Payroll Fraud:  Paying "ghost" employees who do not actually work at the company, making inflated payments to an employee or paying an employee for work not performed.

Cash Larceny:  Stealing cash from the cash register or from petty cash.

Other types of fraud that small business owners should be on alert for include inventory theft; fraud that involves falsifying financial statements; fraudulent invoicing/ billing fraud, in which the company pays for goods/services that are not needed or were never received; and inflated reimbursement of expenses or altering records to hide un-authorized expenses.

Corruption tends to occur more often in larger organizations but should also be considered as a possibility by small business owners.  Corruption always involves some kind of conflict of interest in which the fraudster uses his or her position and influence in the company for personal gain.  For example, an employee demands a kickback in the form of cash from contractors or suppliers in exchange for awarding business, and pockets that cash.  Or the employee diverts business to a family or friend (sometimes paying inflated prices) without disclosing the relationship to management.

Small businesses are susceptible to a variety of actions from its employees which can result in occupational fraud. Business owners, from time to time, get complacent and this opens the door, in part, to this exposure for the business. Vigilance, involvement, asking questions and being in touch with one's feelings about an employee or situation are all useful tools to help an owner of a small business. If a business suspects that fraud is occurring, hiring a forensic accountant early on to investigate can help to minimize the amount of damage and theft that occurs.

Monika Witek, Director

Alan D. Lasko

Alan D. Lasko & Associates, P.C.

Certified Public Accountants

205 West Randolph Street, Suite 1150

Chicago, Illinois 60606

Email: [email protected]

Email:  [email protected]

Website:  www.adlassoc.com