Stories about fraud and embezzlement are common in the media, but most business owners believe it will never happen to them. They think they hire good people who would never, ever be dishonest or steal, especially from their employer.
However, consider these statistics from the Association of Certified Fraud Examiners 2006 Report to the Nation:
- A typical U.S. organization loses 5 percent of its annual revenue to fraud.
- A disproportionate percentage of fraud reported between 2004 and 2006 was committed against small businesses with fewer than 100 employees.
- The median loss experienced by small businesses in the study was $190,000.
- Only 8 percent of the fraud perpetrators had a previous conviction.
The last item is especially troubling because it indicates that while criminal background checks will weed out some problems, most frauds are committed by employees with no criminal record. Also, if your business is a typical organization, you should consider what a loss of 5 percent of your annual revenue can do to your bottom line.
Are You Vulnerable?
Three factors must be present in order for fraud to occur: pressures, opportunity and rationalization. Pressures are outside factors that convince fraudsters of the need to steal. These can be financial or medical issues, addictions (like gambling or substance abuse) or even extramarital affairs.
If pressure is present, the fraudster needs to have an opportunity to commit fraud. This can happen when there are weak internal controls and little or no management oversight. Once these two factors are present, all the fraudster needs to do is rationalize the behavior. Some typical rationalizations include “the company treats me unfairly”, “I deserve a raise”, “I am only borrowing the money”, “It’s for a good cause”, or “It’s only temporary”.
As a business owner, you obviously have no control over the outside pressures facing your employees that give rise to their perceived need to steal from you, or their ability to rationalize theft. What you can control, however, are the opportunities your employees have to commit fraud.
How It Happens
Fraud schemes can continue for years before they are detected, and they tend to get bigger as the fraudster gets greedy or pressures increase. There are two main ways employers give fraudsters opportunities to steal:
- Lack of management oversight While some delegation is essential, too many business owners and managers leave the complete responsibility of managing the finances to others. If the boss is not watching, the trusted bookkeeper, who may be experiencing serious financial pressures, may be tempted to take advantage of this opportunity to embezzle. The next thing you know, the business owner discovers that hard-earned money has disappeared out the back door.To avoid presenting this opportunity for fraud, owners should pay careful attention to their business finances. Just taking the time to look at bank statements and financial reports will go a long way in helping close this opportunity loop.
- No segregation of duties The biggest opportunity for fraud occurs when there is little or no segregation of financial duties. This means that the accounting functions (i.e., data input and export) should be separated from the administrative functions, like invoicing and cash handling. Or in other words, there should be appropriate financial checks and balances in your business.Too often, companies give one person multiple and conflicting tasks, which enables this person to steal and then cover it up. For example, one person might be given the tasks of endorsing checks, filling out deposit slips, taking deposits to the bank and posting customer payments to their accounts. In one, a trusted bookkeeper of many years and close friend of the owner stole incoming checks and then manipulated customers’ accounts to make it appear that they had paid their invoices or were issued credits.In another, a trusted bookkeeper was given the task of writing checks and posting payments to the accounting system. She wrote the checks, had her boss sign them and then erased the payee name and inserted her own. Then she posted the payments to the accounting system under the original payee name, and when the bank statement arrived at the business (to her attention), she promptly disposed of the canceled checks bearing her name. The opportunity was there and she took advantage of it.
These two bookkeepers could never have pulled off their heists if different people were in charge of posting payments and reconciling the bank accounts.
Implement Safeguards Now
It’s important to note that most small businesses have some segregation conflicts and don’t even realize it. Even if your CPA does a full-blown audit, these weaknesses will not always be detected. Therefore, it may be worthwhile to have a professional fraud expert conduct an in-depth study of your company to determine how vulnerable you might be to fraud. This professional can show you how to implement safeguards to help protect your business.
In the end, no one can guarantee that fraud won’t happen. But by watching the financial side of your business closely and putting some simple safeguards in place, you’ll go a long way toward discouraging fraud and protecting your hard-earned revenue.
David A. Landman, CPA, CFE
Gorfine, Schiller & Gardyn, P.A.