Have you ever considered your vulnerability to employee fraud in your small business? Chances are the question has at least crossed your mind, especially if you are entrusting only one employee to handle the company’s money. Like most business owners, you might feel you do not have the time or the resources to implement strong internal controls to deal with the risk of fraud in the first place. Fortunately, there are some simple strategies to help your business be less susceptible to fraud.

This article will explain the key elements for fraud and some simple steps to help prevent fraud. Also included are some examples of common fraud schemes in small businesses.

The 3 Key Elements of Fraud:

You must err on the side of caution when it comes to allowing someone else to handle your money, no matter the degree of trust you have in a particular individual. Also, never underestimate an employee’s ability to come up with creative ways to steal from you company. Identifying the specific vulnerabilities that are unique to your company and Implementing strategies to help prevent fraud, even if the strategies are very simple, should be a top priority . Fraud usually occurs when there are three elements present in relation to the employee and your business:

1) Pressure

often times, there is an external pressure on the employee to steal money:

• to “keep up with the Jones”
• when an employee is facing personal financial difficulties
• caused by an addiction, such as excessive shopping, gambling, drug/alcohol abuse

2) Rationalization

a fraudster will most likely rationalize the fact that he is stealing by telling himself things like:

• “I am the one doing all the work and running this business. I deserve more.”
• “The owner gets to play golf all the time while I am stuck here.”
• “The owner lives in a mansion, drives fancy cars, and goes on elaborate vacation, while I am barely making ends meet.”

3) Opportunity

this element is simply the opportunities that exist in your business to commit fraud. This element is the one you have the most control over. Simple strategies for minimizing the opportunities for fraud include:

• Never give employees the ability to sign checks
  • You and only you should have check signing authority
• Never sign checks without proper supporting documentation
  • Ensure vendors are legitimate
  • Make sure amount of invoice matches amount of the check
  • Check to see if there is a previous balance on the invoice. If so, find out why.
• Consider using a debit or credit card
  • With a company card, it is much more difficult for an employee to create a bogus vendor. The employee would have to add the additional step of setting up credit card processing for a vendor. Additional benefits of a company card:
    • You can set up charge amount limits on the card
    • Credit card companies can assist you in disputing fraudulent charges
    • If you do become subject to fraud, your cash flow will not be immediately affected as will have time to work through the issues.
• Segregate duties when possible
  • Proper segregation of duties is at the foundation for strong internal controls. Unfortunately, most small businesses either do not have the resources or are simply unwilling to hire additional personnel. Owners would be wise to breakdown their current accounting process or accounting cycle to identify where the vulnerabilities are located. Below are some simple examples of duties you might want to segregate:
    • Make sure the employee who gets the mail is not the same person who posts customer payments or vendor invoices
    • The employee who makes the deposit is not the same person who goes to the bank
    • Have a separate person verify when a new vendor is set up

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Common Fraud Scheme Examples

1) Billing

• A bookkeeper who also is a check signer writes herself checks from QuickBooks and then deposits the checks in her personal account. She then goes back into QuickBooks and modifies the payee on the check to a standard vendor of the company.

A bookkeeper might take it a step further and tamper with the check images on the company’s bank statements. Nowadays, It would very easy for an employee to electronically cut and paste a typical vendor check image over the fraudulent check image on the bank statement.

• An employee in accounts payable forms a fictitious company and submits invoices through the mail to her own department. The accounts payable department is in the habit of paying invoices without much scrutiny and pays the invoices of the fictitious vendor.

2) Payroll

• A company has 4 separate check signers. A bookkeeper cuts himself multiple payroll checks on a regular basis. he simply gets a different signer to sign the additional payroll check he might cut himself.

3) Online bill pay

• A bookkeeper simply sets up his own utilities and personal vendors (i.e. electricity, phone, and internet) with the same companies the business uses so that when he pays the company’s bills, he also pays his own bills with company money.

4) Cash register theft

• Common in businesses where inventory is not reconciled with the cash register. Store clerks often ring up returns to get cash when there is no real customer there with merchandise.
• An employee cuts checks to subcontract laborers that are larger than the agreed-to-price, goes to the bank with the laborers and cashes the checks, and then skims some of the money for himself.

5) Company supplies and products

• A common scheme is for an employee to over-order company supplies or products and sell the surplus product on the side.

Please contact us if you are suspicious of fraud in your company or if you are simply interested in strengthening your internal controls.

Written by:

Josh Gardner