Small Business Financial Article
Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.

Will Your Business be a Victim of Employee Fraud?

Will Your Business be a Victim of Employee Fraud?

If your business suffered a $150,000 loss, you would certainly notice it. That could be crippling for many businesses. But, if the loss occurred over a period of time in a drip-drip fashion, it may not be as noticeable, but it would be no less crippling. That’s the median loss small businesses suffer due to fraud committed by employees - that we know of. Most fraud cases go unreported due to the expense of pursuing investigations and prosecution, as well as the hit to the business’s reputation.

Shockingly, nearly two-thirds of businesses don’t believe it can happen to them. What they may not consider is that most fraud is committed by long-time, "trusted" employees who have an intimate knowledge of operations, making it difficult to detect, if it’s detected at all. Drip-drip.

How Employee Fraud Happens

It’s not surprising that most employee fraud targets the financial functions of a business, specifically in the areas of payroll, expenses and procurement, and payments. Among the more common fraudulent activities are:

Expense reimbursement: Submitting phony travel expenses or padding the amount of charges

Employee credit cards: Using business credit cards to pay for personal expenses

Payroll fraud: Creating a phantom employee with fake time logs or padding time logs to receive overtime pay

Procurement: Creating a purchase order for goods or services and diverting them for personal use or creating a phantom vendor account through which phony invoices are processed with funds paid to the employee as the phantom vendor.

Receivables (Lapping fraud): Customer receipts are stolen, and then the next receivable is applied to cover the theft.

There are dozens of variations of these common fraud activities that can occur across nearly all business functions. While you can’t know which type of fraud may be committed, you can look for tell-tale signs that the risk of fraud is increasing in your business.

What to Look For

The challenge for businesses is there are rarely any overt indications that fraud is occurring. But, if there are internal controls in place, there are red flags that can alert you to specific behaviors that should be monitored, including

  • An employee whose lifestyle has noticeably changed - i.e., driving an expensive car, taking lavish vacations, wearing expensive clothes
  • Employees who give some indication of financial troubles
  • An employee who is always first to arrive at work and the last to leave
  • An employee who has an unusually close relationship with a vendor

While there may be a rational explanation for any of these behaviors, employers need to know their employees well enough to recognize changes in personal circumstances, temperament, or productivity that could be considered unusual behavior. Having regular face-to-face meetings with employees is an effective way to monitor behavioral changes.

How to Prevent Fraud

Employees who commit fraud do so because the opportunity is there. So, the most effective way to prevent fraud is to remove the opportunities.

Separate accounting functions

Most financial fraud occurs when one employee controls multiple financial functions (i.e., Payables and receivables). While it may increase your costs, splitting accounting functions will remove the opportunity for one of the more costly forms of fraud.

Rotate functions

Set up a rotation calendar for employees who perform high-risk functions. It will require cross-training, but it will reduce opportunities.

Establish a Fraud Tipline

Most fraudulent acts are reported by employees, vendors, and customers. Make it easier for them by establishing a phone hotline or a link on your website specifically for reporting fraud.

Establish and Enforce Internal Controls

Employees should know to expect an internal audit at least once a year. If your budget allows, contract an outside auditor at least once every couple of years. In addition, the business owner or office manager should review and approve all invoices.

Establish a culture of intolerance

Businesses that spend time talking about fraud with their employees, including their roles and responsibilities in preventing it, are less likely to experience it. When talk is backed up by proactive measures to prevent it, it is less likely to happen at all.

The issue is not whether employee fraud can happen in your business - of course it can. You hire human beings, and human beings are fallible. Employee fraud occurs most when the opportunity presents itself. The real issue is whether you take it seriously enough to prevent it from occurring in the first place.

Read Other Small Business Financial Articles