Five measures help smaller companies stop the fraudsters
What you may not know is that the median loss for smaller organizations is estimated at $150,000, as identified by the Association of Certified Fraud Examiners 2010 Report to the Nations.
Why is fraud such a factor in small businesses? Typically it is due to a lack of checks and balances, as it is not feasible to hire additional employees to segregate job functions. In addition, most small companies lack anti-fraud controls. Segregation of duty issues plus limited anti-fraud controls equals opportunity for fraud.
The good news is that there are ways for small businesses to reduce the opportunity for fraud without breaking the company’s bank. The following prevention measures are cost-effective and can be easily implemented to combat internal and external fraud schemes.
1. Positive Pay:
Positive Pay is an automated tool that most banks offer to prevent fraudulent disbursements within customers’ accounts. With Positive Pay, the bank can match check number, amounts and even payees against an approved list of checks to be paid. Checks that do not meet the pre-approved list from the business will not be allowed to clear the bank account.
This tool significantly reduces external fraud threats stemming from the theft of a company’s identity, including its bank account number. Positive Pay also mitigates the risk of employee fraud such as an employee cutting checks for unapproved vendors for personal gain. Keep in mind the approved check list submitted by the company to the bank should be reviewed and submitted by an employee independent of the accounts payable function.
Positive Pay, if implemented correctly, is a fantastic anti-fraud tool that can assist with segregation of duty issues. For example, had a small organization that our firm followed implemented Positive Pay, it most likely would have prevented its executive director from embezzling more than $750,000. The scheme consisted of the executive director issuing fraudulent disbursements in the form of checks to himself and his credit cards.
Small businesses that have opted for PaySimple’s ACH pay system and wire payments instead of issuing checks can implement tools similar to Positive Pay to prevent fraudulent transactions.
2. Lockbox banking:
Small businesses that receive customer payments through the mail should consider lockbox banking. Many banks offer lockbox banking, in which customer payments are sent directly to a lockbox (or multiple lockboxes depending upon preference) to be processed and deposited into the company’s account. Utilizing lockbox banking significantly reduces the threat of customer payment theft by employees and also helps with untimely deposits.
Recently an organization fell victim to a common employee fraud referred to as “cash for checks lapping scheme,” perpetrated by its accounts receivable clerk. The scheme lasted for four years and totaled more than $250,000.
The clerk removed cash from daily deposits and replaced the cash with customer checks. The customer accounts in the accounting system were eventually adjusted for misapplication of the checks. The scheme was uncovered when source documents of the cash receipt process were compared to the physical deposits of cash. Lockbox banking would have removed the opportunity for an accounts receivable clerk to perpetrate this scheme.
3. Inventory awareness:
Sound funny? It shouldn’t. Inventory theft is becoming more of an issue as dishonest employees are able to sell company products online for personal gain. Small businesses that either purchase raw material or create a product that is smaller in nature and reasonably valuable are at greater risk for inventory theft. Companies should thoroughly investigate inventory shrinkage and examine segregation of duties when it comes to purchasing raw material, receiving product, inventory counts and shipping.
Multiple examples of employees taking products ranging from ink cartridges to diabetic sensors to sell online for personal gain have been documented. Red flags within the victim organizations consisted of employees with incompatible job functions (for example, purchasing, inventory counting), unexplainable inventory adjustments and employees taking home cardboard boxes before being broken down.
Yes, believe it or not, a simple step in mandating that all cardboard boxes be broken down before an employee removes a box from the premises could prevent fraud. For one particular organization, this was a $940,000 lesson in which they learned an employee was removing boxes of diabetic sensors to sell online.
4. Anonymous reporting system (also known as a fraud hotline):
According to the Association of Certified Fraud Examiners, more than 40 percent of frauds are uncovered through tips. Organizations should consider implementing a third-party anonymous reporting system for employees to report fraud, in either the form of an external hotline number or an online submission form that employees can use to report suspicions. Many third parties provide this service for a reasonable fee.
Organizations that are considering a reporting system often fear improper use of the system by disgruntled employees. Although this is a legitimate concern, it is better to know about potential issues than not. Certainly, all reports should be investigated, but oftentimes the reports lacking merit can be readily identified without exhausting significant time and money.
5. Pre-employment background checks:
Background checks of potential hires should be considered by all organizations. The position to be filled should dictate how exhaustive the check should be. For example, it may be appropriate for a background check of a controller to include criminal and credit to identify past history and potential financial pressure, as this person would be entrusted with an organization’s assets. Other positions such as assembly workers and truck drivers may not warrant the need for a credit check.
An organization recently became victim of inventory theft by an employee with a previous grand larceny conviction. Had the organization conducted a criminal background check, the organization most likely would have uncovered this employee’s past criminal history. Believe it or not, the job application completed by the employee falsely indicated he had never been convicted of a felony.
Small to medium-sized businesses do not have to spend a fortune to possibly save a fortune due to fraud. These five measures, if implemented properly, will greatly reduce a company’s fraud risk in a cost-effective manner. Moreover, having anti-fraud controls in place provides not only potential fraud loss savings, but peace of mind to business owners, managers, investors and other third parties, such as lenders.
Jason Olson,
Eide Bailly Forensic &
Valuation Services:
612.253.6554
jwolson@eidebailly.com
www.eidebailly.com
