Uncovering Fraud in a Small Business

It's hard enough managing a small business but when your small business is confronted with fraudulent activity by an employee, it is almost crippling. Five percent of a typical businesses revenue is lost to fraud each year. This five percent adds up over time and unless the fraud is uncovered, it can create cash flow problems down the road that jeopardize the equity you have built up in your small business. Historically, over 80% of all fraud involves the theft of cash. Sadly it is the longtime employee who is often the perpetrator of the fraud. The employee who attends your family weddings, funerals and celebrations, can be the same employee perpetrating the fraud. Such employees rationalize their behavior (justify it) in their minds, no matter how egregious the crime might be to a rational small business owner.

Uncovering Fraud:
Ironically, in most small businesses, the bookkeeping department is commonly the most frequent avenue in which fraud occurs.. How does fraud occur in small business?

1. Dual Cash Responsibilities - In a small business, the employees who deal with incoming and outgoing cash are the ones with the greatest opportunity to commit fraud. Small businesses, due to human resource constraints, often give their bookkeepers dual responsibilities such as recording the incoming and outgoing cash and reconciling the bank accounts. Such dual responsibilities give the bookkeeper the opportunity to commit and cover up fraudulent activities. To prevent this type of fraud it is best to separate and periodically rotate the recording of cash coming into an organization (accounts receivables functions) and the cash going out of the organization (accounts payable functions). Additionally,outsourcing the bank reconciliation to your CPA, will act as a checks and balance in uncovering fraud. You should advise your CPA to analyze and verify all ATM charges that run through your bank statement, with the small business owner. If your small business also utilizes a company credit card it is wise to verify and analyze all credit card charges on the credit card statement every month, with the small business owner.

2. Dual Disbursement Responsibilities - If you allow the same employee to set up vendor accounts and approve disbursements you are giving them opportunities to defraud you. Separate these functions internally. In a small business, the owner should be the one approving disbursements.

3. Billing Schemes - Billing schemes are easy to commit. The typical billing scheme occurs when an employee causes a payment to be issued to either a nonexistent vendor or to a company controlled by the employee. Many employees in these situations have checks sent to their personal residences. This is a scheme that builds over time. It starts out small and, over time, snow balls into a much larger theft. In order to prevent this type of fraud, a small business owner should verify all vendor addresses. Simply cross checking the vendor address on the checks to the telephone book can be all the verification you need. Cross checking a vendor address to employee residential addresses is also a good idea. If the address is a P.O. Box, securing a telephone number for the vendor and calling that number is another good idea. Every vendor should have a corresponding telephone number. If one doesn't there may be a fraud-related reason for this.

Without any process to uncover fraud, the fraud will continue year after year. That is too bad. By implementing some simple internal controls, a small business owner can stop the fraud in its tracks and preserve their hard-earned equity for retirement.