How to Avoid Billing Fraud

Billing fraud is the most common type of fraud that small businesses experience, accounting for 27% of all fraudulent activity.
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Billing fraud primarily occurs in one of three ways, when employees:

1. Submit fictitious invoices for a vendor that does not exist (also known as a “shell company scheme”)
2. Inflate invoices for a real vendor that is unaware of the fraudulent activity occurring
3. Invoice the purchase of personal items

​While employees may justify their illegal actions due to need or entitlement, billing fraud ends up costing small businesses billions of dollars every year.

Fraud Facts

• The most common fraudulent business activities are billing fraud, corruption, check tampering, skimming, and expense reimbursement fraud.
  
  
• The occurrence of fraud is inversely proportional to the size of the company, which is to say that as the size of the organization increases, the likelihood of fraud decreases.
  
  
• Small business fraud is likely even more common than statistics would indicate because small business owners are less inclined to prosecute offenders than larger organizations. Many instances go undocumented because family members and trusted employees are not turned in for their crimes.
  
  
• The average billing fraud scheme lasts 2 years and costs the company $100,000.

Business owners must understand where their companies are vulnerable, how to uncover fraudulent activities, and what types of precautions to take to prevent the costly effects of billing fraud.

Fraud Vulnerabilities

Whenever trust is present, that trust can be exploited for personal gain. Business owners at small, private companies are more likely to hire friends and family than their larger counterparts or publicly traded companies. Employing people who already have a close relationship with each other inherently creates a tight-knit culture. This type of environment breeds trust, which can create opportunities for fraudulent activities.

Small businesses also have fewer employees, which makes it difficult to segregate duties properly. In some small businesses, the same person is responsible for accounts payables, cash reconciliations, and maintaining financial reports. The result is a critical fraud vulnerability due to a lack of oversight. When there are not enough employees to divide duties effectively, some financial functions may need to be outsourced or externally audited to reduce vulnerability.

While large organizations typically have extensive accounting control systems, smaller companies tend to lack these types of procedures. Missing accounting controls make businesses more vulnerable to fraud. Access controls, required purchase authorizations, standardized templates, trial balances, reconciliations, and data backups all contribute to reducing fraud vulnerability.

Discovering Fraud

The earlier fraud can be identified, the better. When employees are committing billing fraud, they can become more brazen over time, stealing larger quantities the longer fraudulent activities go unnoticed. As a result, the cost to the business can increase exponentially over time, reducing the chances that the business will be able to recoup lost profits once the scheme is detected.

Discover fraud as early as possible by:

• Investigating sudden cost increases or profit decreases.
• Keeping a closer eye on employees who experience a major life event that can act as a financial stressor (i.e. marriage, birth of a child, death of a family member, or the diagnosis of a serious illness).
• Monitoring employees who suddenly exhibit signs of untrustworthiness such as excessive spending or shifting working hours to be alone in the office frequently.
• Questioning an employee’s desire for total control over financial functions.

The most effective way to uncover fraud is to hire a third-party forensic accountant or auditor to examine business financials. Auditing accounts payable, cash accounts, credit accounts, and payroll can identify simple errors and detect ongoing fraud schemes to keep employees honest.  

Preventing Billing Fraud

The fraud triangle asserts that for fraud to occur, three elements must be present – opportunity, perceived pressure/motivation, and rationalization. An organization can only control the first of these three. Therefore, its best defense is removing any opportunity for fraud by mitigating business vulnerabilities.

Without acknowledging that anyone is capable of illegal activity, business owners cannot be vigilant enough to thoroughly protect the company. While some fraudsters steal for greed, many others do so because they are unexpectedly in a difficult financial situation. Some thieves may even justify their activities by reasoning that they will replace the money before the theft is discovered. While business owners certainly need to trust their employees to create a positive working environment, unabated trust is a dangerous scenario.

Billing Fraud Checklist

1. Implement an accounting system to organize and track bills
2. Utilize separation of duties
3. Verify original invoices (not subsequent bills) to ensure the billing amount and payment terms are correct
4. Verify time periods to avoid paying duplicate bills and ensure billable time periods are not shrinking
5. Regularly check vendor invoice numbers – if invoices are inconsistently numbered or consecutively numbered investigate immediately
6. Require a physical address and phone number on all vendor invoices
7. Establish an approved vendor list to confirm only legitimate vendors are being paid
8. Periodically reach out to existing vendors to ensure invoices received match their records
9. Ensure all employee expenses are directly related to the business and exclusively support business activities
10. Require original receipts (not copies) to verify employee expense reports

Hiring an accounting firm is a shrewd way to guarantee these billing best practices will be executed correctly. Leaning on a third-party provides the impartiality needed to discover past fraudulent activities and avoid future instances of fraud. Contact us today!
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