What Small Business Owners Need to Know About Employee Fraud
By Shelley A. Drury, Managing Director
Although all small business owners would like to think their employees are loyal and trustworthy, employee fraud is a real concern and losses can quickly add up and significantly impact revenues.
Types of Fraud
Fraud can come in many forms, but the most common in small business and professional practices is asset misappropriation. Asset misappropriation includes, but is not limited to:
- Employee using a business credit card to pay for unauthorized personal purchases;
- Employee stealing cash before it has been recorded as revenue;
- Theft of inventory, electronics, and supplies; and
- Employee submitting false reimbursement claims.
Ways to Help Prevent Fraud and Manage Risk
The Hiring Process
First and foremost, perform a complete background check on any employee you hire. There are a number of third-party companies that provide this service at very little cost.
Have an internal control system in place where duties of the office staff in particular are diversified. A good internal control system will, as a rule of thumb, not have just one person performing multiple steps of a transaction. A good internal control system has checks and balances in an effort to ensure documented processes are followed.
For example, the controller or office manager prepares checks to be signed and then those checks go to the owner with appropriate documentation for signature. Depending on the size of the business and transactions being processed, consider requiring dual signature on all checks or on checks above a certain dollar amount. If something looks wrong, it probably is – don’t sign the check until you’ve satisfied yourself that it is for a valid, approved business purpose.
As another example, an individual taking payments (cash payments in particular) should not have access to the accounting system. If the person taking payments also has access to the accounting system, they can easily “cover up” their theft by posting a write-off to that client’s account keeping the client’s balance correct while pocketing the cash.
Internal controls, including documented processes and procedures are only helpful if they are strictly followed by every member of the organization, starting with the business owner.
Open Lines of Communication
It is critical for business owners and managers to create an environment where employees are well-trained on processes and procedures. Employees should feel comfortable to voice their thoughts regarding process improvements, efficiencies, and concerns. An ideal environment would be one that encourages employees to come to the owner and/or management directly to report any red flags.
Reports and Monitoring
A good business owner should be regularly monitoring various financial reports, including comparisons of budgeted revenue and expense actuals. Any significant variance should be further investigated.
Business owners should have the business bank account statements, check copies, and credit card statements sent to their personal residence. Even better, owners should have online access to their business accounts and should periodically monitor account activity. Owners should look over transactions and make sure something doesn’t stand out as odd. If it does, ask more questions. If everything looks good, the owner should supply that information to the appropriate employee (or independent contractor).
Collection and write-off reports should also be analyzed by the owner(s). If there are write-offs to client accounts you didn’t approve, stop and further investigate.
Watch for Red Flags
Some common red flags for business owners to watch for are:
- Monitor employee vacation balances to ensure appropriate amounts of vacation are being taken. Require that employees take at least half of their vacation every year. Often times, employees who are committing fraud are reluctant to take vacation because their scheme is more likely to be uncovered.
- Know your employees!
- Look for sudden changes in attitude. A feeling of unappreciation by certain employees can contribute to their willingness to commit fraud as a form of revenge or, conversely, contribute to them justifying their behavior because they think they “deserve” more.
- Look for lifestyle changes that don’t match their income level. Is your office manager suddenly driving a new car, wearing new clothing, remodeling or purchasing a home? If these changes are observed, there could be very valid reasons that don’t include fraud (spouse’s income increased, inheritance, debt), but can be red flags, especially if more than one red flag is observed.
- ACH payments or wire transfers to seemingly unknown sources or duplicate sources (two payments to the credit card in a single month, two payments to the insurance company in a single month, etc.). An individual who enters a transaction to be paid/transferred electronically should never be the person who approves that transaction. Controls at the business’s banking institution should be in place that require approval.
- Unexplained purchases.
- Payments to new vendors you don’t recognize.
Business owners should lead by example and be aware of areas their business may be at risk. Employee fraud in particular is usually committed by the most trusted employee – the employee who the business owner would never think is capable of doing such a thing. They are commonly in an administrative role handling payments and deposits and have access to the accounting software.
Individuals commit fraud at both small and large companies in any variety of manners. Setting up good internal controls and monitoring those controls regularly is far less time consuming and expensive than having to detect fraud after the fact. Usually by the time fraud is detected, the money has been spent and is difficult to recover. Business owners should consider purchasing insurance coverage (sometimes referred to as “employee theft” or “employee dishonesty” coverage) to recover losses due to the fraudulent activity of one or more employees.
Shelley A. Drury