Small Business Susceptible to Fraud

By: Andy Echols, CPA/ABV, CFE

The Association of Certified Fraud Examiners (ACFE) issued its 2008 Report to the Nation on Occupational Fraud and Abuse and organizations with fewer than 100 employees were hit the hardest. The median loss suffered by small business was $200,000, which is higher than the median loss of the largest organizations (10,000 employees or more).  According to this same report, U.S. companies lose 7% of their annual revenues to fraud and the typical fraud lasted two years from the time it began until the time it was detected.

The two most common fraud schemes impacting small business were check tampering and fraudulent billing. Examples of check tampering include an employee that steals blank company checks and makes them out to himself or an accomplice, as well as stealing or altering checks to a vendor and depositing it into his own bank account. Examples of fraudulent billing include an employee creating a shell company and billing the employer for nonexistent services, as well as an employee purchasing personal items and submitting an invoice to the employer for payment.
 
According to the 2008 Report, only 7% of fraud perpetrators in the study had prior convictions and only 12% had been previously terminated by an employer for fraud-related conduct. Fraud perpetrators often display behavioral traits that serve as indicators of possible illegal behavior. The most commonly cited behavioral red flags were the following:
  • Perpetrators living beyond their apparent means
  • Perpetrators experiencing financial difficulties
Other potential fraud warning flags within a company include the following:
  • Lack of or weak internal controls within the company, including a lack of proper segregation of duties
  • Unexplained inventory shortages
  • Unexpected or unusual decrease in earnings
  • Noticeable personality changes in employees
  • Complaints of errors or shortages from customers
  • The absence of original invoices, but rather using copies instead
Depending on the size and complexity of a business, there are numerous anti-fraud programs and internal controls that can be implemented. Below is a list of some of the most effective and proven anti-fraud controls, many of which are inexpensive to put into practice:
 
  • Establish a third-party hotline service where employees can anonymously report fraudulent activity. Tips continue to be the most common means of fraud detection.
  • Establish a proactive anti-fraud policy and ensure the company’s standards, procedures and penalties are effectively communicated.
  • For cash disbursements, segregate the duties of preparing checks (an authorization duty), signing checks (a custody duty), and the preparation of monthly bank reconciliations.
  • For cash receipts, segregate the duties of cash handling (receives cash and checks, prepares deposit slip, etc) and recording receipts in the accounting records.
  • Receive bank statements unopened and review for unusual activity.
  • Use positive pay banking controls (the bank verifies items presented for payment against the list of checks the company submits beforehand).
  • Rotate job responsibilities and require mandatory vacation.
  • Review a vendor listing for suspicious vendors and approve new vendors.
  • Implement surprise audits.

The Dent, Baker Advisor

Dent Baker routinely provides information and relevant articles via our electronic newsletter titled "The Dent Baker Advisor."

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