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Internal Fraud Prevention

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The sale of a business prompts business owners to review lots of documents such as income statements, client lists, and vendor billing reports.  For some, working through the accounts with an M&A Advisor prompts the first review in years.  After all entrepreneurs are busy developing products and services, meeting customers, and being managers. Clients frequently tell us that “the books are my bookkeepers’ responsibility.” 

The truth is that businesses are vulnerable to fraud, and small and medium size enterprises are at particular risk as they have fewer controls due to a lack of personnel or financial resources.  It is a sad reality that some employees use their position for personal enrichment through occupational fraud.  According to the Association of Certified Fraud Examiners (ACFE) 2008 Report to the Nation on Occupational Fraud & Abuse, “The median loss suffered by organizations with fewer than 100 employees was $200,000.”  The two areas of most common fraud schemes were check tampering and fraudulent billing, though other examples include expense reimbursement, payroll, register disbursement, cash larceny, and other forms of corruption.  Most occupational fraud schemes differ from other forms of theft in that they are ongoing and can last for months and years before detection. 

While never paranoid it does make sense to have a sense of healthy and appropriate vigilance.  Perpetrators often display behavioral traits that serve as indicators of illegal behavior. The most common are perpetrators living beyond their apparent means (39% of cases), experiencing financial difficulties at the time of the fraud (34%), wheeler-dealer attitude (20.3%), control issues such as unwillingness to share duties (18.7%), divorce / family problems (17.1%), unusually close association with vendor / customer (15.2%), irritability, suspiciousness, or defensiveness (13.6%), addiction problems (13.3%), and past legal or employment problems (8.7% and 7.9% respectively). 

A study conducted by the Institute for Corporate Productivity, in conjunction with HR.com, points to current economic conditions as a catalyst for increased levels of workplace crime, specifically theft.  Of employers surveyed, 18% of respondents reported increasing employee-related monetary theft and 24% of respondents reported increased theft of company-owned items – office supplies, food, etc.  While it may be the last thing employers want to worry about in a challenging environment, this study seems to imply a need for special attention to the matter.

How does one stop fraud? Fraud is most commonly detected in small companies by tip (41.7%), by accident (29.6%), by internal audit (10.7%), by internal controls (17.3%), by external audit (14.3%), and through police notification (3.3%). 

Fortunately, according to the ACFE, “The implementation of anti-fraud controls appears to have a measurable impact on an organization’s exposure to fraud.”  Effective controls can detect and prevent fraud and have an enormous impact on profitability often cutting the cost of fraud in half or eliminating it altogether.  Examples of effective controls include:

  • Surprise Audits
  • Job Rotation / Mandatory Vacation (entails others in office assuming work)
  • Hotline (anonymous avenue of communication for those who respect wrongdoing)
  • Employee Support Programs (easy access to drug and alcohol abuse programs for example)
  • Code of Conduct
  • Rewards for Whistleblowers

The study from the Institute for Corporate Productivity found that 28% of employers are relying on increased communication with employees on the matter to curb fraud. Additionally, 20% are conducting extra audits, and 19% are spending more time focusing on background checks prior to hiring to prevent problems.

These steps can absolutely improve the profitability and salability of your company.  It’s never a bad time to tidy up your operation.  Never cede control of your business while you own it.  A few hours reviewing documents and a general sense of vigilance can be well worth the time.  It’s just good business. 

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Posted Aug 2010
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