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The Importance of Checks, Balances and Due Diligence

Checks, balances and due diligence.  Small businesses lose almost twice as much per scheme to occupational fraud. Median loss - $200,000 for businesses with less than 100 employees; Median loss - $104,000 for businesses with 100+ employees. Source: 2018 Report to the Nations. Small business fraud facts - fraud detected by tip = 29% - fraud caused by lack of internal controls = 42% - fraud perpetrated by an owner/executive = 29%. Most common occupational fraud schemes in the U.S. are corruption at 30%, billing at 26%, noncash at 21%, expense at 17%, cash on hand at 15%, check and payment and tampering at 15%, skimming at 14%, cash larceny at 11% and payroll at 10%. Most common anti-fraud controls in the U.S. code of conduct at 73%, external audit of financial statements at 69%, employee support programs at 62%, management certification of financial statements at 61% and internal audit department at 60%. Do's and Don'ts of Fraud Protection are as follows: Do's - know your employees; conduct background checks on potential hires; carry out due diligence regarding senior-level employees; look for suspicious behavior; make unannounced informal audits; control cash receipts, provide fraud awareness training for employees and managers; support and encourage employee tips. Don'ts - accept only a resume of work experience provided by the applicant; assume previous employers performed full due diligence; accept anonymous reference letters; make accusations and conduct investigations that can lead to lawsuits.

The Importance of Checks, Balances and Due Diligence

“An ounce of prevention is worth a pound of cure” is good advice for small business owners who want to avoid fraud schemes that can cause serious financial and legal problems. If undetected over an extended period, these schemes can be disastrous for a small business and ultimately cause it to fail.

Unfortunately, a common perception among many small businesses is that fraudsters only target large companies with deep pockets and abundant resources. But statistics tell us a different story.

A comprehensive study by the Association of Certified Fraud Examiners (ACFE) found that more than 30 percent of fraud incidents occur in small businesses, which was higher than any other business size category. Fraud schemes also account for small business losses that are almost twice as much as companies with 100 employees or more, according to the ACFE.

Fighting fraud

The ACFE reported that a simple lack of internal controls was responsible for nearly half of all fraud cases involving small businesses, followed by the ability of an employee to override the controls that were in place (19 percent) and a lack of management review (18 percent).

The most common small business fraud involves someone within a company manipulating a financial transaction. Check and payment tampering, skimming (diverting business funds), billing schemes, inflated expense reports, falsified invoices and embezzlement of inventory are the cause of nearly one-third of small business failures, according to the U.S. Department of Commerce.

These financial schemes are often very subtle and hard to detect unless you know what to look for. Payroll schemes can take up to 24 months to detect, the ACFE reported. That’s where initiating fraud prevention strategies can help you and your employees detect and deter these schemes from gaining traction.

Anti-fraud strategies

The first step in preventing these types of fraud is to hire trustworthy employees. The National Federation of Independent Business (NFIB) encourages small business owners to perform background checks on candidates being considered for hire, especially employees who will be dealing with money or financial records.

Before vetting new employees, you may want to consult with a human resource expert about best hiring practices. Sensitive positions, such as chief financial officer, are too important for you to rely solely on an applicant’s written statements, which may or may not be accurate. You may want an HR professional to check police records, run credit bureau reports and conduct interviews with references.

You should also have a fraud policy or code of conduct that explains company policies and procedures for reporting suspected fraud, as well as rules governing the termination or prosecution of employees who have committed fraudulent activities.

Installing security cameras, changings keys and badge access to storage areas are effective strategies for preventing potential thefts of valuable property such as computer systems or inventory.

Ferreting out fraud

As a business owner, you are encouraged to methodically check online banking and credit card statements for unusual financial transactions that may indicate possible fraud. Whenever suspicious activity is detected, you should notify your bank or credit card provider immediately so they can prevent further losses. The AFCE found that proactive data monitoring and surprise audits were associated with a 50 percent reduction in fraud losses.

Using automated fraud detection systems, backed by trained examiners, banks and credit card companies, can also assist you in uncovering suspicious transactions such as purchases made for large amounts or in distant locations. While effective, this service does not replace your responsibility to initiate anti-fraud measures to protect your company.

In suspected cases of employee fraud, consult with your attorney or a human resource specialist regarding issues of confidentiality before making accusations. Whenever fraudulent activity is uncovered, notify law enforcement authorities and, after charges are filed, prosecute the perpetrator. Failure to prosecute is a disservice to other business owners who could be victimized by the same unscrupulous employee.

Even when fraud is detected, the ACFE found that in 53 percent of the cases nothing is ever recovered and only 15 percent of fraud cases make a full recovery. All things considered, it is obvious that fraud prevention is more effective than detection and prosecution which can be expensive, time-consuming and produce a disappointing rate of recovery.

 

About the Author: Clint Sporhase leads First National Bank’s efforts to serve small business owners. Clint has 25 years of sales, marketing and strategy experience.

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