Falling victim to fraud as a business owner is a nightmare that we wish no one had to face, but unfortunately, it is a reality of business ownership we must take steps to protect ourselves against. So how do you prevent fraud in your small business? While fraud is a topic many people don’t enjoy discussing, it is important to address for business so that you may detect suspicious activity and better protect yourself. We’ll provide some guidance on how to protect yourself and avoid the ramifications of fraud.
What we cover in this episode:
- 01:11 – How often does fraud happen?
- 04:42 – Impact of fraud on small to medium-sized businesses
- 07:44 – Five most common types of fraud for small businesses
- 14:36 – Protecting your business – Small business fraud prevention
- 29:07 – Watching for red flags
- 32:09 – Conclusion
How often does fraud happen?
We’d all like to think that occurrences of fraud are rare, and that we can trust the people we do business with and hire. Unfortunately, fraud is more widespread than you would think. Some recent statistics from BusinessFraudPrevention.org say that 28% of small businesses experience fraud, and comparatively, and larger businesses experience fraud at a rate of 22% to 26%. That is a large number of businesses that have to go through the experience of dealing with fraud, and unfortunately, it is not as rare as you would think.
The BusinessFraudPrevention.org website has resources, provides examples of some of the more frequent types of fraud that occur, and highlights some high-risk areas in your business that are most susceptible. According to their statistics, billing and payroll fraud occur twice as often, and check and payment tampering occurs 4 times as often.
Impact of fraud on small to medium-sized businesses
How could fraud potentially impact your business? If you don’t currently have anything in place to prevent fraud from happening in your business, the damages can be far-reaching and extensive, but it depends on the level of fraud involved.
If someone is stealing money, that’s going to potentially affect the cash flow in the business and prevent things from functioning properly. Your productivity can take a hit as well, because you may not have the resources now that you potentially would have had. The growth of your business is also at risk.
Another big impact of fraud is the damage it can do to your professional reputation. It depends on the type of business you run, but word can get around quickly in small circles, and harm your brand, your potential for getting new clients, and you can lose current clients or customers as well. Fraud within a business can damage your organization internally and can shake the foundations you’ve built. It can affect you, your employees and leadership team across the board with emotional ramifications.
Five most common types of fraud for small businesses
The 5 most common types of fraud that a small business might encounter can help you focus your efforts on the most susceptible areas. You can prioritize these areas first and avoid some of the overwhelm that can come with trying to protect every single area with processes and procedure. This is not an inclusive list of course, but if you can protect yourself against the top five, you can have some level of protection and minimize the impact that fraud can have on your business.
#1: Payroll fraud
The first one we already mentioned in the statistics before, and it’s payroll fraud. This includes things such as submitting a false number of hours worked, getting extra paychecks for employees, and even creating false employees.
#2: Cash theft
The second is cash theft, and it can be dangerous. If your business collects a lot of cash it can be easy to grab when it’s right there in front of someone, and it’s also hard to trace.
#3: Online banking
The third is online banking fraud. It has become more common in society for people to use online banking because it’s a great convenience. You have to be careful with the access to this in your business and make sure controls are in place, especially access to banking transfers.
#4: False invoicing
False invoicing is fourth, and it involves someone creating and submitting false invoices to your accounts payable for payment of supplies, materials, or services they did not provide. False invoicing can also be diverting payments into different accounts from a real supplier’s invoices.
#5: Invoice email
The last of the five is something called invoice email. This is where someone is perpetrating the fraud to email, and pretending to be a current vendor or supplier, and changing terms or payment arrangements.
Protecting your business – Small business fraud prevention
Unfortunately, there is no internal control system in the world that can stop every type of potential fraud. Fraud still happens in businesses, but you can certainly put as many safeguards in place as possible to try and avoid it from happening.
One of the first things you can do is hire carefully. It may be time consuming, but you should always ask for and investigate references of potential hires. Running appropriate background checks is important as well. Red flags can appear in their history that can exclude someone who may be asked to handle cash, etc.
You should vet the potential employee well, and set expectations for the core values and code of conduct that you expect if they become an employee. You also want to be sure to educate and cross train the new hire. Having someone cross trained in different positions and duties brings value to you and your business. It’s also harder for someone to perpetrate fraud if another person could step into their shoes and then discover that fraud when they step away from those tasks.
Procedures & internal controls
You can also minimize risks of fraud by developing procedures that separate duties, and also establish internal controls. There should be a series of checks and balances in place for every process and procedure you have in your business. Internal controls for running payables, payroll, accounts receivable, et cetera, all the way down to running a cash drawer. You can institute a plan to rotate job responsibilities periodically to minimize risk.
It’s always good to get a fresh set of eyes on things that are happening in different areas of your business. They may spot irregularities or fraud, and on the flip side, they can be in a position to bring a new outlook on tasks and help with efficiencies or positive changes. You should always make sure you are keeping control as an owner of what is happening with your finances in your business.
Small businesses don’t normally implement internal audits, but this can be another area where you can protect yourself. When you think about audit, you think of the IRS or financial auditors for regulatory purposes, but you can set up your own internal audit to audit yourself. You can ask someone internally, or bring in someone externally to validate transactions and check out certain things to make sure nothing funny is going on.
Watch for red flags
Some people have a sixth sense about these things, and just “know” when something is “off.” There are a few things we have seen in our work as CPAs that we can share. One thing to to look out for is when an employee does not want to take vacations or time off. Sometimes they are just really hard workers, but perhaps they don’t want anyone to see what they are doing in their jobs, and that could be a big red flag.
Watch for changes in patterns in your business, such as cash flow patterns, stock shrinkages, variations in accounting ratios and even customer complaints. These can all be red flags that something is just not right.
If there is something that is unexplainable, hard to explain, or just doesn’t fit the narrative of what is happening, then it could be a sign of trouble. Casual changes in patterns can happen occasionally, but they typically have plausible explanations. If they don’t, then it may be a red flag and time to dig a little deeper to find the underlying causes to see what is happening.
Another thing to keep an eye out for is people who may work for you that seem to be living beyond their means. It’s something auditors discuss, and can spot red flags if all of a sudden someone is purchasing luxury items and doesn’t seem to have the salary to support that type of spending. It may be that they have a wealthy spouse, or it could be they are getting the money from somewhere else.
Fraud in small businesses happens more often than you might think, but putting controls in place to minimize risks, and mitigate the potential for fraud is something every business owner can do to reduce the chances of fraud happening to them. Focusing on putting controls in place to protect yourself and your business for the most common types of fraud can give you some peace of mind and hopefully protect you from the ramifications of fraud.
Links mentioned in this episode: