Small businesses are the most vulnerable to occupational fraud and abuse, according to the Association for Certified Fraud Examiners (ACFE). In its 2002 Report to the Nation on Occupational Fraud and Abuse, ACFE cites that the smallest organizations, 100 employees or less, suffered higher median losses than did the largest organizations (10,000 employees or more). While the largest companies suffered losses of $97,000 on average, small businesses' losses averaged $127,500 based on its survey, which was conducted between April 2001 and February 2002.
Considering the potential losses, it behooves small-business owners to make the prevention of fraud a priority in their businesses. Though no business owner wants to feel it employs unscrupulous people, sometimes temptation or personal financial pressures can push even the hardest working, most trusted employee into perpetrating fraud.
The first step in preventing employee fraud is letting employees know you're watching for it. "Perception of detection is a very powerful deterrent," says John Gill, a certified fraud examiner and general council and director of self-study publications for the ACFE. Through its report findings and the experiences of its members, the ACFE has honed in on effective methods for deterring occupational fraud and abuse. Here, Gill shares some of the most useful approaches, which are also detailed in its book How to Prevent Small Business Fraud. Some methods seem commonsense, but when taken into consideration with other preventive measures, they help fortify a business against fraudulent activity.
First and foremost, hire the right employees. Conduct background checks for people handling inventory and money. Check past employment, criminal convictions, references, and education and certifications. Also, conduct drug screening since often, according to Gill, employees will steal from a business to support an addiction. Remember, however, to always get the written consent of candidates before doing research since many federal and state laws govern the gathering of such information.
Maintain strong internal controls. Have checks and balances in place, suggests Gill. "For example, you don't want a signatory on the bank account balancing the check book," he says. "If I can write checks on the account and I reconcile the bank book, I'm free to manipulate the check register."
Make sure expenditures are approved. For every expense, have a manager and someone in accounting approve it. The supervisor will ensure that the expenses are valid, while accounting will run the math.
Monitor cash situations. In a retail situation, Gill suggests having security cameras monitor activity at registers and storage areas where inventory is kept. "People are less likely to do it if someone is watching them," he says.
Conduct surprise audits. Catching an employee off guard could be your best bet in discovering fraud. "The key is that an employee generally doesn't know what's coming and won't have the time to change the records to hide the fraud," says Gill. Additionally, auditors have sampling and computer data analysis techniques that help uncover fraud. Using these techniques, auditors can quickly examine, say, the payment of 1,000 invoices in detail, including invoice numbers, to whom payments were made, and when payments were made, and quickly determine those that are suspicious. "We've seen cases where somebody creates a phony company, submits invoices to accounting and accounting sends payment to a P.O. Box," says Gill. In one case, Gill recalls, an employee who set up a fraudulent business through which he submitted preprinted, consecutive numbered invoices to his employer every few months. When the auditors examined the invoices, particularly the invoice numbers, it seemed funny to them that the business submitting the invoices didn't have other clients or was having an extremely slow year since each consecutive invoice was sent to the company. A surprise audit also can uncover duplicate invoice amounts and duplicate invoice numbers, both of which can be red flags for possible wrongdoing.
Establish a third-party hotline service. According to Gill, the number one method for catching occupational fraud is getting tips from employees. Because most employees are reluctant to report suspicious activity, using a third-party hotline offers a level of anonymity that an in-house hotline might not provide, making employees more likely to blow the whistle on fraudulent activity. An outside company is staffed 24 hours a day and provides information to the business immediately.
Create a fraud policy. "Don't create anything complicated," says Gill. Simply inform employees during employee orientation, training programs, memorandums, or other communication that fraud is not tolerated and let employees know what to do if they suspect fraud. Also, be sure to inform employees of the actions the company will take if it suspects or determines fraud has been committed.
Enforce mandatory vacations. "Our research has shown that if employees don't take vacation, it can be a red flag," says Gill. "They're afraid to go on vacation because someone is going to find out that something is not right." Requiring employees to take time off can aid in the prevention of some frauds.