Is your company at risk? Steps to prevent business fraud
What to know about insider fraud
- It’s quite common, so most likely you’ve been a target.
- Types of fraud: asset misappropriation, corruption/bribery, financial statement fraud
- Small businesses are more vulnerable, lacking safeguards.
- Recognize red flags that may indicate fraud.
- Learn steps to prevent fraud.
Employee dishonesty is more prevalent than we’d like to admit. Let’s face it: No one wants to think that one of their hand-picked employees may be stealing from them or cheating them. Yet it happens more often than we’d think. Keep reading to learn how to spot red flags so that you can prevent business fraud at your company.
“Fraud is now so common that its occurrence is no longer remarkable, only its scale,” says the Association of Certified Fraud Examiners (ACFE). “Any organization that fails to protect itself appropriately faces increased vulnerability to fraud.”
Types of insider fraud
The risk of insider fraud, better known as occupational fraud, permeates every industry – even education, religion and charities. Occupational fraud is typically divided into three buckets: asset misappropriation, bribery/ corruption and financial statement fraud.
Besides inventory theft, asset misappropriation also includes theft of money, check forgery, payroll fraud or theft of services. Examples include skimming payments received from customers, overstating reimbursable expenses and intercepting outgoing vendor payments. It’s the most common type of fraud (happens in 91 percent of fraud schemes, says AllBusiness, but it’s also the least expensive type of fraud.
Corruption, the next bucket of fraud, occurs in about 30 percent of fraud cases. The fraudster uses their influence in a business transaction to obtain personal benefit. It can include failing to disclose conflicts of interest, manipulating contracts, substituting inferior goods, bribes to influence a decision, kickbacks and shell company schemes.
Financial statement fraud results in three times the loss as the other two combined, although it’s the least common, occurring in only 10 percent of cases. It includes manipulating financial statements in order to create financial wins for an individual or group, such as playing with stock prices, loan terms or year-end bonuses. It can also involve intentionally misreporting financial information to mislead others, such as the IRS, debtors or investors.
Related: How to prevent employee fraud
What does a typical fraud event cost?
The typical organization loses five percent of its annual revenues to fraud, says ACFE and the Center for Forensic Economic Studies. The median loss from one case of occupational fraud is $150,000, but nearly a quarter of these occupational or insider fraud cases resulted in a loss upwards of $1 million. A portion of their infographic is at left; view the entire infographic here.
At the high end of the spectrum are median losses in wholesale trade at $450,000, agriculture/forestry/fishing/hunting at $300,000 or construction at $259,000. We hear a lot about employee theft at retail organizations, yet their average case is $85,000. At the low end of the spectrum, as reported by ACFE, is education, at $62,000 per event. (Again, a portion of the ACFE infographic is below; view the entire infographic here.)
Their studies also show that the more conspirers there are involved in a fraud, the higher the losses are: one person defrauds their company of an average of $65,000. Two people, $150,000. Five plus people, $633,000.
Related: Insurance fraud: Red flags to help agents spot potential fraudsters
Why are small businesses more vulnerable?
If you own or manage a “small business” (i.e., less than 100 employees), know this: nearly one-third of fraud cases occur in small businesses. Even scarier, 60 percent of these companies didn’t recover any of their losses – and their median loss is $150,000.
Top fraud risks for small businesses are: Corruption, 30 percent. Billing schemes, 27 percent. Skimming, 20 percent. Check tampering, 20 percent. Non-cash misappropriation, 19 percent.
When they spot fraud, these organizations of 100 employees or less typically detect it in one of these ways:
- A tip – 30 percent
- Management review – 15 percent
- Internal audit – 12 percent
- Account reconciliation – 8 percent
- Just by accident – 7 percent
Here’s the kicker: We all think it won’t happen to us. Our employees like us; no one would cheat us. We like to think we keep a close eye on the books and take basic steps to prevent fraud. And our head-in-the-sand attitude costs: companies without anti-fraud controls suffered twice the losses of those that had controls in place. Those controls are typically management review, proactive data monitoring and analysis, and an employee hotline.
What red flags should I be aware of?
ACFE says that when an employee exhibits these behaviors, they pose a red flag of potential fraud:
- Living beyond their means. Does the big spender’s salary line up with their spending?
- Wheeler-dealer attitude. An employee bragging about playing fast in loose in their personal life should raise suspicion.
- Financial problems. Often the cause of employee fraud, these could include mortgages, high student loan or credit card debt, car loans.
- Close personal relationship with vendors or customers. Be aware of the possibility of collusion or conflict of interest.
- Unwilling to share duties. Sharing job duties could result in being caught, so fraudsters may not use their allotted time off, or they might come up with excuses to gatekeep information from their colleagues.
- Acting defensive or suspicious. Fraudsters may act unusually paranoid or harsh with colleagues, ACFE says, in order to project suspicion onto others or to discourage questions.
Steps to prevent business fraud
ACFE lists six steps every organization should consider to reduce your vulnerability to fraud:
1. Establish a company-wide code of ethics for management and employees, and have each employee sign the document.
2. Evaluate your internal controls for effectiveness and identify areas that may be vulnerable.
3. Institute more checks and balances, such as
- Adding an audit department and/or an independent audit committee
- Requiring management review and certification of financial statements
- Requiring a consistent external audit of both financial statements and of your internal controls over financial reporting
- Conducting random surprise audits
- Instituting mandatory vacations or job rotation
4. Hone your hiring procedures. Conduct thorough background checks that include educational, credit and employment history, plus references.
5. Create a tip line. ACFE says fraud is most likely to be detected by a tip, so provide an anonymous reporting system for employees, contractors and clients.
6. Communicate your stance on fraud – consistently. Remind staff of your anti-fraud policies and potential consequences, and that your tip line is anonymous and easy-to-use. Consider anti-fraud training for executives, managers and employees.
Related: How widespread is insurance fraud? [infographic]
Need more information on steps to prevent business fraud? ACFE has a free, downloadable fraud prevention check-up form so that you can determine how vulnerable your company may be. It also provides some prevention methods and policies to help you get started.
This blogpost originally ran as advice for agency owners. It has been modified and updated to better fit the needs of business owner clients.