In Pursuit of Profit
Read our expert article below or sign up to get articles sent to your inbox.
The possibility of business fraud is the dirty little secret that business owners tend to ignore. Unfortunately, there will always be unscrupulous individuals that try to take what is not theirs, even during hard times. Recent reports of bookkeeper fraud serve as a reminder to business owners that fraud never stops, even when businesses are down on their luck. In fact, a global fraud study found that, on average, companies lose 5% of their yearly revenue to fraudulent activities.
While it is easy to imagine fraud occurring by faceless cybercriminals or strangers sneaking in to rob your company of cash and valuable assets, most perpetrators have deep ties to the business, and many are first-time offenders. Many times, the people you least expect are the ones responsible for fraudulent activity – long-time employees, close friends, and even family. These bonds can make it difficult to spot the warning signs, causing fraud to go undetected far longer than it should.
In a profile on what makes someone commit fraud, CFO Selections explains that only three factors need to be present for fraud to occur – pressure, opportunity, and rationalization. This explains how even the most trustworthy employees and partners can find themselves tangled up in fraud, and business owners can be so shocked when they discover that fraud is happening at their organizations.
As a business owner, one of the most important things you can do is understand which types of fraud are most common to equip you to identify and prevent fraud at your business.
Types of Fraud
There are many different bookkeeping fraud schemes that business owners need to be aware of these days; however, most fall within five main categories:
Inside the Mind of a Fraudster
How does fraud happen?
Business fraud is most often committed by regular people (not hardened criminals or professional con artists) that experience three key things – pressure, opportunity, and rationalization.
The stress of financial pressure is the impetus for fraudulent activity. This pressure can be the result of almost anything – a gambling problem, substance or alcohol addiction, medical bills incurred due to health issues, the desire to maintain an expensive lifestyle, a family member’s financial misfortune, and so on.
When people do not think that they will be caught stealing, that creates the opportunity they are looking for and allows an easy avenue for committing fraud. A lack of financial controls or lax company culture creates an opportunity for fraud even among otherwise honest people. Not having the correct checks and balances or entrusting one individual with too many financial functions makes fraud easy to commit and cover-up. Broken processes can also fuel fraudulent activity by allowing fraud to be written off as simple errors or mistakes.
To perpetuate the fraud, fraudsters need to justify what they are doing, so they rationalize their actions. Common rationalizations include statements like: I’ll pay the money back later, I deserve this money because I’m undervalued in my role, the company won’t miss the money because it has plenty, other people are doing it too, and I really need it for something important.
Remember, first-time offenders are typically committing crimes of opportunity, not intention, which means that these crimes can be avoided with the right internal controls in place.
Identifying and Preventing Fraud
How do you know if bookkeeping fraud is happening at your company?
During the hiring process, you check references and run background checks, but do you continue to monitor employees over the years? Most companies fail to carry out this crucial step. Look for employees that are discussing their family issues, living beyond their means, showing signs of addiction, or having financial problems.
When employees or partners are committing fraud, there are some red flags to watch out for, such as:
Implementing internal controls is the most effective way to prevent fraud – divide duties and practice oversight for all employees regardless of seniority, likability, or previous track record. Even with the right controls in place, you should still spot check things like payroll records, vendor payments, and supplier orders periodically to ensure that they are all legitimate. Lastly, establish a culture of integrity and transparency to give the sense that all employees must adhere to rigorous ethical standards. Practice open communication and expect the same from your employees. Remember, the best way to avoid fraud is to eliminate opportunities to commit fraud.
If you are concerned that bookkeeping fraud is occurring at your company, hire a third-party accountant to check your books and ensure the proper internal controls are in place.