In a 2014 study, The Association of Certified Fraud Examiners’ (ACFE) revealed that the typical organization loses an average of 5% of revenues each year due to fraud.
5%! That’s HUGE! Small Businesses are at even higher risk of fraud due to a lack of turnover and financial controls in place to prevent fraud. You might not see it on the local news but we see it often as CPAs and in most cases, it could have been preventable. The good news is that you can implement simple, common sense financial controls in your business that will help mitigate the risk of fraud.
Give me the BIG PICTURE!
In order to prevent and detect fraud, it’s essential to develop a segregation of duties, which limits the employee’s ability to commit and conceal during the normal course of their job. The normal segregation of duties are the following:
- Authorization or Approval
- Custody of Assets
- Recording of Transactions
If you have an employee performing more than one of these duties, then you are at higher risk for theft.
The easiest way to understand this concept is with examples:
You wouldn’t want an employee to open the mail and receive a check (Custody of Assets) and also have the ability to delete an invoice or accounts receivable in the accounting system (Recording). Otherwise, an employee could steal the check and delete the transaction so no one knew it was missing.
You wouldn’t want an employee to deposit money in the bank account (Custody of Assets) and also reconcile the bank account (Reconciliation). Otherwise, an employee could steal the bank deposit and enter a fake transaction on the bank reconciliation to cover it up.
You wouldn’t want an employee to approve time cards (Approval) and also create paychecks for employees (Custody). Otherwise, an employee could add ten additional hours to his or her timecard fraudulently!
Here is the problem…
For most small businesses, having enough employees to design an effective segregation of duties is cost prohibitive. However, you can implement a few simple steps to make your business safer from fraud.
Step 1 – Attitude!
By far the biggest problem when it comes to fraud is attitude; the feeling that fraud could never happen to you. It only happens to someone else. From my experience, the worst frauds I’ve seen occurred because no one ever cared to look or ask a question. One of the main barriers to attitude is the feeling of guilt that employers have because they don’t want employees to feel an aura of distrust. The truth is, the implementation of financial controls protects the Company AND employees by mitigating the ability to commit fraud in the first place. Remember that 5% I discussed earlier? A healthier bottom line is better for the company and employees.
Step 2 – Review
Simply reviewing the accounting records with a skeptical eye and getting involved in the accounting enough to understand the numbers is a big step to mitigating fraud. Here are a few tips on items to review:
- Review your bank statements and bank reconciliations to look for bank transactions that you don’t recognize. On the bank reconciliations, look for odd items such as old outstanding checks that haven’t cleared the bank.
- Review your payroll reports and employee benefit invoices. Look for employee pay and time that is incorrect or even a fake employee! Review the health insurance invoice to look for unapproved benefits being paid such as family coverage added to an employee policy and paid unknown by the employer (I’ve seen this fraud before).
- Review invoices to be paid side-by-side with the checks to be signed. Look for fake vendors that could have been set up by employees and look at the addresses where the service was provided. Are you paying for your own utility bill or your employees?
Step 3 – Consider hiring a professional
The right contracted bookkeeper or CPA can provide several benefits to help detect and prevent fraud. Having good financial statements and records is key. By reviewing well prepared financial statements, you can look at income and expense variances and ask questions. Understanding your financial statements and comparing them to other key factors in the business can help understand if fraud could be present. A CPA that has experience in audit and attestation can also work with you to review your financial controls and make customized suggestions for your business.
Fraud is big business for criminals. Don’t make it part of your business. Implement these simple steps today to safeguard your organization.