How to Protect Your Business From Occupational Fraud

The first time fraud really hit home, I had just started GrowthForce and was looking for our first clients. I was sitting at the Kingwood Chamber of Commerce next to a guy who did landscaping. I was cutting my own grass at the time and didn’t want to do it anymore. So I asked him if he would barter. He became our first client. Just two months in, he called to tell me that his longtime office manager had been stealing from him and he didn’t know what to do.

He was devastated because they had known each other for so long. I felt for him like a family member in distress. I rolled up my sleeves and went over there to find out just how deep things were.

We were blown away by how close they came to having to shut down the business.

The Office Manager Committed Payroll Tax Fraud

I was shocked to see how much burden was on his shoulders.

Besides the embarrassment, it was the risk of financial collapse that was the worst part. This was not just a mistake - this was his whole identity - both his and the business.

He kept asking himself, “how could I be so stupid?”The office manager ran the entire office, so we were able to go into the audit trail report and prove what happened. She was stealing the payroll taxes -- we proved it out to the FBI but she was already long gone. Her apartment was empty and she had moved on to the next victim.

What’s amazing is how common businesses, especially small businesses, become victims of employee fraud and theft. I had never felt so compelled to learn about the seriousness of fraud in business until that day.

The true story above is just the first in my many experiences with clients who were victims of fraud.

Small Business Fraud Statistics

I feel it is important to share with you some recent and very sobering facts from the “Report to the Nations on Occupational Fraud and Abuse: 2016 Global Study” by the Association of Certified Fraud Examiners (ACSE).

I was surprised to learn that each year, companies lose approximately five percent of their revenue to fraud. In 2016, the median case of fraud amounted to $150,000. However, in almost a quarter of reported cases, businesses lost more than $1 million.

If you’re thinking, “This isn’t going to happen to me,” then it’s good that you’re reading this!

The ACSE study also showed that small businesses more often fall prey to occupational fraud than medium-sized and large companies. And for small businesses, fraud can be literally devastating.

First of all, it’s far more challenging for them to overcome the kind of financial hit we’re talking about. And second, few small businesses have the resources to overcome the reputational damage fraud can cause, especially when customers and employees are also directly affected.

Your business cannot afford that type of risk.

Forms of Small Business Fraud

I learned that there are many forms of fraud, but the following are the most prevalent:

• Cyber threats: Since small businesses usually don’t have the budgets for top of the line security systems and processes, they’re particularly vulnerable to cyber threats. Most of these threats begin with some form of phishing: emails that appear to be trustworthy but are intended to trick recipients into clicking on links that surreptitiously install malware on their computers. Note that while we often think of malware and other breaches as hacks into a network, there are numerous instances where employees have installed malware and/or stolen data from within their companies’ networks. Malware includes ransomware, as well as scripts that record keystrokes and send data back to the cybercriminals. They typically sell the confidential information on the black market or use it to impersonate high-level executives and try to deceive employees into transferring large amounts of money to them. They can also use bank account and routing numbers to commit ACH fraud.
• Billing fraud: More than 27 percent of all reported cases involve billing fraud, which occurs when an employee either inflates existing invoices or creates fake ones and submits them to the employer for payment. Billing schemes usually run for two years before they’re discovered and cost companies an average of $100,000 per case.
• Check tampering: More than a fifth of fraud cases in small businesses involve check tampering, which cause average losses of $158,000. A fraudster can forge the signature on a check; change the payee’s name to his or her own; or slip fraudulent checks into a batch for the owner to sign in the hopes it won’t be noticed. In some cases, an employee who’s authorized to sign checks for the company abuses that authority to steal funds.
• Cash skimming and lapping: On average, these forms of fraud cost $53,000 per incident, and they amount to 12 percent of all cases. Both involve the misappropriation of cash by an employee before it’s deposited into the company’s account.
• Payroll fraud: Approximately 8.5 percent of cases involve payroll fraud, and on average, this type of fraud causes losses of $90,000. Payroll fraud occurs when an employee inflates his or her salary or pads billable hours with (over)time that wasn’t actually worked. In some cases, an employee with access to payroll pays wages to “ghost employees” and cashes the checks himself or herself.
• Expense reimbursement fraud: This type of fraud causes losses of $40,000 per incident and is responsible for almost 15 percent of all cases. It involves submitting expense reports that are either inflated, fictitious, or mischaracterized (i.e. personal expense submitted as business expenses).

How to Protect Your Business

The key for me is to make sure that fraud prevention starts at the top. You need an ethical leadership team that’s committed to best business practices and encourages this mindset at all levels of the company. This makes it easier to implement the processes and protocols necessary to discourage fraudsters from targeting you.

The most important thing to understand about fraud is that it thrives in businesses that don’t have a system of internal controls.

Internal controls are specific processes that safeguard the correct and timely flow of financial data into your accounting system. Interestingly, they also provide you with clear insights into your financial data, which can help you make more informed, strategic decisions to help your company grow.

Even if you only have a few employees and limited resources, you can set up a basic internal control: the separation of duties. This involves ensuring you never have the same employee performing more than one of the following tasks: authorizing transactions, recording transactions, and reconciling or checking accounts.

I have witnessed first hand how many small businesses benefit significantly from outsourcing their payroll, bookkeeping, and accounting functions. Because every step of every transaction is reconciled and verified by external professionals, it’s easier to detect fraud. Moreover, outsourcing acts as a deterrent for would-be fraudsters who are generally more confident about their abilities to pull the wool over their colleagues’ eyes than to deceive professionals they’ve never met.

Additionally, you should educate your employees about the various types of fraud scams and schemes. This will help them understand why certain processes have to be adhered to; plus, it will make it easier for them to recognize signs of fraudulent behavior.

Finally, it’s advisable to provide a way for employees to anonymously file a report if they suspect fraud is being committed. Remember: Employee tips are the No. 1 way fraudsters are caught—but if your employees fear repercussions and don’t feel safe, they won’t speak up if they notice anything amiss.

Stay Informed

I’ve learned that fraudsters are always developing new ways to misappropriate business’s money. That’s why it’s important to stay informed about new cyber threats, scams, and other fraud schemes. You can do this by signing up for the Association of Certified Fraud Examiners' Fraud Info Newsletter.

In addition, you can create a Google alert for “occupational fraud” and “fraud” to receive alerts about new mentions of fraud as they happen. This is a good way to get the latest information and saves you precious time in searching news publications for fraud-related stories.

Conclusion

I hope this brief overview helps you to see how fraud can impact your business, and how you can minimize the chances of becoming the victim of business fraud. To learn more, I’m happy to share our recent eBook, “The CEO’s Guide to Reducing Fraud” where you’ll find much more information about the various types of fraud, building systems of internal controls, and the important role outsourced bookkeeping and accounting service providers can play in fraud detection and prevention.