6 Top Tips to Avoid Small Business Fraud

 

As a small business owner, you may have strong bonds with your team members. You likely know them well, with everyone wearing multiple hats. And that can be a wonderful thing!

Unfortunately, however, small businesses are more susceptible to business fraud than large corporations, according to the Association of Certified Fraud Examiners (ACFE) 2020 Report to the Nations. The global study also found that small businesses (those with 100 or fewer employees) suffered median losses of $200,000 due to fraud, while organizations with 100+ employees saw an average of $104,000.

So yes, it’s more common than you may think! That’s why taking steps toward preventing small business fraud is crucial to protecting all you’ve worked for. Below, we’re touching on what these schemes can look like and six essential tips to prevent fraud among your business and employees.

What Does Business Fraud Look Like?

Typically, individuals engage in fraud when the “fraud triangle” occurs, meaning an individual or company has the motivation (i.e., some perceived pressure, like financial stress or job dissatisfaction) and opportunity to commit fraud and a way to rationalize it. The three main categories of business fraud include asset misappropriation (i.e., theft), corruption, and financial statement fraud.

So, which one is most common? If you said employee theft, you’d be correct—it made up 86% of fraud at about $100,000 per case, according to the ACFE report. This often occurs when an employee or external party steals or misuses an organization’s assets. Asset misappropriation includes schemes like embezzlement, theft of inventory or cash, fraudulent disbursements, and misuse of company resources.

Then there is corruption, which occurs when employees in a position of power abuse their authority for personal gain via bribery, extortion, conflicts of interest, and other unethical conduct. Corruption accounts for 43% of fraud at about $200,000 per case.

While financial statement fraud makes up just 10% of fraud, its repercussions can be significant, pushing $1M per case ($954,000). These schemes involve purposely providing misleading or false information in financial statements to deceive stakeholders. Activities can include financial records, intentional misrepresentation of financial information, overstating revenues or understanding expenses, and other tactics intended to present a false financial picture of the company.

Again, small and medium-sized businesses are at higher risk than large businesses, and employees commit most fraud. In small teams, owners and employees often see one another as friends and sometimes family (or they are family). While this leads to a deep level of trust, it can also lead to:

  • A few key employees wearing multiple hats

  • Too much trust among staff, giving them too much freedom

  • A lack of review and internal controls

  • Limited financial experience

  • Serious effects on cash flow—it doesn’t take much for a small business!

Another scary stat? The median duration of a business fraud scheme is 14 months. Some cases, like those involving payroll and check and payment tampering, last up to two years. We don’t have to tell you the massive losses you could incur month after month. On that note, let’s dive into those fraud prevention tips.

6 Ways to Prevent Business & Employee Fraud

Verify & Get to Know Your Employees

The first step toward business fraud prevention is getting to know your employees! Yep, this begins with the new hire paperwork, specifically Form I-9, Employment Eligibility Verification, which you must complete for every employee. While you’re required to fill out an I-9 for every employee on their first day of work and file it within three days of their start date, it also ensures you have their information and know exactly who is working for you.

Conducting background checks is another key way to ensure you can trust your team members, particularly those handling money and bank account information. Ensure you follow state and local background check laws, as certain jurisdictions restrict when and how you conduct them.

Simply getting to know your employees is essential, too! Pay attention to their work habits, schedules, and other things going on in their lives. Monitor their vacation time—if they haven’t taken any in a long time, they might have something to hide and be concerned about someone discovering their fraud if they are out of work.

Finally, create a positive culture of honesty and integrity. Employees feeling frustrated and unappreciated can increase the chances of fraud and other misconduct. Additionally, financial or other pressures can cause the best worker to do unsavory things. Sadly, it’s often the ones you least expect!

Establish Internal Controls & Segregate Duties

Many small businesses lack internal controls and segregation of duties, which is why they’re more vulnerable to fraud. In fact, lack of internal controls is a contributing factor in 26% of fraud cases. So implement yours and audit them regularly! 

For example, when you receive an email requesting something like changing bank account information, train your team to:

  • Not simply do something they get from an email request

  • Double-check the email address and call the employee or vendor to verify it came from them

  • Be skeptical and go with their gut!

Segregation of duties is also vital! This means:

  • Limiting access to financial account data and inventory

  • Requiring multiple signatures on expense reimbursements, overtime, checks, and accounting/payroll functions

  • Ensuring the person preparing the weekly payment run is not the same person signing the checks

When it comes to your vendors or contractors, always obtain their W-9s so you have their information. You can even do an Employer Identification Number (EIN) search to verify their legitimacy if you want to. And, of course, be wary of any address that’s a P.O. box.

Protect Your Bank & Credit Card Accounts

One of the first things you should do when you launch your own business is set up separate business and personal bank and credit card accounts. This ensures that if scammers access one account, they can’t get access to the other, meaning they can’t get to ALL of your assets.

Another area to safeguard is reimbursements—this is where many cases of employee fraud occur. Put a solid reimbursement policy in place and track employee expenses closely. Take advantage of credit card fraud protections, like automatic alerts for expenses over a set amount.

You can also ask your bank if they have an ACH debit blocker feature (for ACH withdrawals) and positive pay (for checks). With these features, your bank sends you a report in the morning of pending checks or ACH transactions from the day before, which you have to approve or deny. Remember, the longer you go without noticing an issue, the less likely you’ll be to get your money back. Put your regular bills on autopay so that your ACH debit blocker and positive pay features catch any unusual activity. 

All this to say, you can mitigate fraud while being efficient! You should know every penny coming out of your account. However, implementing positive pay will save your team time reviewing all the check and ACH activity.

Investigate Every Report

Setting up fraud prevention controls is only as good as your team’s effectiveness. You have to actually look into any reports or suspicious activity and be willing to dedicate the time and resources to do it. Often, small businesses only implement fraud prevention after an event has occurred—when it should be before!

Then, follow through on your policy regarding employee misconduct and enforce it appropriately. Investigate every case, no matter how big or small!

Stay Up-to-date & Aware

One of the best ways to avoid business fraud is to stay up on the latest scams so you and your team know what to look out for. Check the news regularly to understand what fraudsters are trying to do!

One common scheme is a fraudster posing as an employee or vendor and emailing someone on your payroll team requesting a change to their bank account information. This is where those internal controls come in! 

Be vigilant, cautious, and objective. Don’t simply trust every email or request, and train your team to do the same.

Educate Employees & Establish a Reporting Process

Speaking of training your employees, educate them on the red flags, prevention measures, and how to report business fraud and suspicious behavior. Set up an anonymous reporting system that allows employees to report suspicious activity through a website or hotline while protecting their identity. 

It’s essential to create an anti-retaliation policy and ensure employees know they will not receive backlash for reporting fraud, theft, or other misconduct. Staff will then be more likely to submit tips, which is crucial—the ACFE found that 43% of frauds are detected by anonymous tips!

Final Thoughts on Small Business Fraud Prevention

Remember, employees commit the most common business fraud cases through misappropriation and theft. Focus on building a culture of honesty, maintaining employee relations, developing a policy on employee conduct and expectations (if you haven’t already), and incorporating fraud prevention measures. 

These events often occur due to too much oversight, excessive trust in employees, lack of internal controls, and segregation of duties. If you need assistance establishing fraud prevention methods or want a third-party accounting team to strengthen your segregation of duties, JLS Accounting can help! Book an intro call with us today to learn more.