We all hear about fraud here and there. We take solace that if our credit card is lost or stolen that we are not responsible for more than $50 and that the bank will resolve any issues we detect when reconciling our bank accounts. However, fraud in small business is so much more. The scary part is that it happens so much more than these basic personal risks.
It gets complicated for business because it just plain happens. The familiar pattern is once it occurs and goes undetected or unconfronted it grows and can become huge.
Let’s understand the philosophy of fraud, commonly referred to as the ‘fraud triangle’. Certain conditions seem to create an atmosphere that promotes it and it’s important that the small business owner understand these conditions. It all starts with opportunity. Let us face it, no matter how secure internal controls are, opportunity is constantly created or can be devised by those seeking to develop such opportunity. There are a certain percentage of employees that will act solely on opportunity. For the purposes of this article, we will assume that the employee approval process, complete with background checks will minimize the risk of your business hiring these folks. You do perform background and credit checks on all prospective employees, right? Well, if not, you run the risk of relying on interview policies and skills to do more than most businesses have learned to expect. So then, please, commence the credit and background check process on all new hires to identify those who will likely steal solely when afforded the opportunity to do so.
Another side of the triangle is pressure, generally financially related. The pressures can range from spending beyond means, to unexpected (like health of a loved one) bills, to compulsive behaviors. Suffice it to say, that its pressure that greases the wheels for the normally honest employee to succumb to the temptation of opportunity. Once the slide is greased, and should fraud theft not be detected or confronted, nor the principal’s culture be one that the employees believes that they will be caught, pressure will allow the temptation to grow. It grows like a cancer and there is nothing left to stop it once the last side of the triangle occurs.
Rationalization is when the perpetrator develops a perception that they are entitled to commit fraud. We see it in our current political environment, that the wealthy make too much, and the common folk are left to suffer. Other rationalizations include just rewards when passed over for a promotion.
What matters is that the level of attention a business owner or principal devotes to fraud sends a powerful signal to employees about its importance and prevention. So, is fraud prevention part of your company’s culture? We operate in an environment in which employment surveys note that up to 5% of job applicants have a fraud history. Now this damaging information won’t appear on their resumes as small businesses rarely prosecutes the fraud perpetrator. For you as small business principal, it all starts with observation of how much or well things are watched over. Therefore, it’s all about management, and how well you or your structure manages and supervises is incredibly HUGE.
Several business routines will minimize loss, improve employee performance and when you work to prevent fraud from inside your organization, you win. You see, 37% of fraud is initiated by internal sources. You need to prepare for fraud strikes from inside your organization, it’s all about your management culture! Structuring work and carrying out day-to-day responsibilities with an eye toward fraud prevention can best work to stop fraud from happening. Home-grown security, and your hard work to support a culture of control and accountability, will positively affect your overall business prosperity. Unfortunately, it is the simplest of fraud prevention actions that are the least likely to be taken by small business owners.
Let’s start with the simplest precautions that you can use to save yourself from future fraud trouble. Research who you hire because it has been determined that 5% of workforce has some level of dishonesty or has previously been involved in fraud. With hiring levels reaching near capacity of the workforce, it is not unreasonable to expect that a greater percentage of present job applicants have previously dirty hands. You see, small businesses does not have the resolve nor resources to prosecute guilty parties, but as small business owners we need to change that.
It is vital to use due diligence with thorough interviews, to obtain valid independent references and make calls to past employer. The excuse that we don’t have enough time for formal background checks just doesn’t cut it, so under no circumstances can they be skipped as they are required to build a trustworthy team. Don’t find out after a breach that the warning flag was waving and you looked away.
As accountants, we are constantly asked about appropriate segregation of duties. Yes, we understand that they have a cost, but the risk adjusted cost of a loss is higher. No more cost-effective strategy has been developed. Building a company culture of honesty starts with Executives. Think of employees as a family and realize that, like children, employees see and understand everything. Don’t give any single employee too much authority. Structuring appropriate separation of duties with financial checks and balances avoids the concentration of too much power in one person.
Large companies expend huge resources to train employees and it just seems, due to limited resources, small business seems to not follow this lead. But it is important to give you and your employees the confidence that business finances are being handled correctly. Set up training sessions to teach employees how they can help prevent fraud with diligence. Taking the time to annually remind employees of the values and expectation that fraud will not be tolerated is the only method to build a culture that can stand the test of time and excel at profitability. Build into the daily operations of your business that adherence to operational guidelines, roles and responsibilities is the ONLY option. Automation of financial transactions removes the human involvement and thus minimizes the risk of fraud. Online banking services provide transaction, balance and utilization reporting for easier reconciliation. Realize though, that the reconciliation is quite important as online access to bank accounts is available without a check or authorized signature. It is believed that only half of small business owners review bank statements, credit card charges and accounting books. Frequent reconciliation identifies financial red flags early. Adjust your individual thought process to put on your fraud hat! You need to think like a thief, can you do that? Take improvement culture to a new level, by establishing an avenue for employees to annually report areas of improvement. Make sure that you act on important suggestions, and, even if it is deemed to be too costly to protect against, consider buying insurance! Showcase and reward the employees that report and suggest! Listen to them, they are in the trenches of your business warfare.
Another option for reducing the risk of fraud and to better uncover weaknesses is internal audits and reviews. Utilize your CPA for more than meeting filing requirements and maybe saving taxes. Coordinate on vulnerable areas and realize they are a tremendous resource of what is being accomplished at other small businesses when you encounter a specific threat. Regular fraud audits signal your commitment to reduce fraud and keep your business secure.
Yes, this can all be quite costly. Yet, we haven’t yet found the alternative solution to this potentially business closing risk. As we mentioned earlier, the loss costs of fraud can be huge and those re not simply in the form of dollars, but also in reputation and lost revenue. Please take away that you have no choice but to invest! Please share with us your ideas so that we can all do it better!
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