According to the Wall Street Journal, employee fraud increases during an economic downturn. So, not only are business owners forced to survive the economic crisis, but also they must “check the pockets” of their employees. This makes it especially tough for smaller businesses who don’t have the time or resources to implement strong internal controls, to counteract the temptation of employee fraud.
The Association of Certified Fraud Examiners (CFE) stated that fraud associated with smaller businesses cost more on average then that of larger firms. It was also reported that the average cost of fraud for one small business, with fewer than 100 employees, was $200,000 in 2008. Most importantly, the most common of these frauds were fraudulent billing, check tampering, and sales skimming schemes. Find out more regarding EINs here.
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Fraudulent billing – (Represented 28.7% of the total frequency of fraud schemes, conducted on small businesses with fewer than 100 employees in 2008.) This type of scheme represents the largest in dollar loss for small business owners. It is very important that business owners are especially cognizant of this type of crime because it takes careful planning and premeditation on the part of employees, and outside individuals.
The fraud is accomplished by doing the following:
-An accounting manager creates a phony shell company, with an accompanying bank account under the name of the fraudulent company. A fake invoice from the shell company is then created, which is fraudulently billing the accounting manager’s employer for “materials purchased”. Then the accounts payable clerk, knowingly or unknowingly, sets up a vendor account for this phony shell company, cuts a check, then sends it to a P.O. Box address. The scammers later cash the check and pocket the cash…then the cycle is repeated again. It’s easier to find the cheapest state for limited liability company.
An accounts payable clerk works in cahoots with an existing vendor, requesting that the vendor inflates their prices or short delivers. The cash is then split amongst the vendor and employee.
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Solution: You must have segregation of duties to avoid this problem. In addition, you should always review the Approved Vendor list to check for P.O. Box addresses. Is there more than one address? Also, check the vendor addresses against all employee addresses to ensure that they don’t match. Another great strategy, is to look up names of unfamiliar companies on the internet or the yellowpages to validate their legitimacy.
Check Tampering – (Represented 25.4% of the total frequency of fraud schemes, conducted on small businesses with fewer than 100 employees in 2008.) This type of fraud is becoming more popular and sophisticated. The scammers alter legitimately issued checks, thus manipulating the check to suit their scheme. There are several ways that this scheme is achieved. Here is a sample of a few:
- A check is issued to a vendor by the office manager. The payee line is altered and a new payee’s name is entered (i.e. the office manager’s boyfriend). The check is recorded into the system with the name of the vendor, then the check is cashed by the scammers.
- The office manager finds a box of blank checks. He then enters the name of the payee, which happens to be his mother. The check is forged, cashed, and then split with his accomplice.
- The accounts payable manager takes home an existing issued check, chemically erases the ink off of the check, then rewrites the entire check. Not surprisingly, the crooks cash the check and then takes the cash. *This is a very sophisticated method, and if done correctly it can be very hard to visually see that the check has been altered.
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Solution: Securely and expeditiously lock all checks in a secure place, and allowing only one employee to have access to them. Again, segregation of duties is key here because the same person who has access to the checks and issues them, should also not be the same person to reconcile them. Additionally, all checks should bear a holograph on them to make it impossible for check washing schemes. Most importantly, an audit of the the canceled checks against the check register should be done regularly as a preventative measure.
Sales Skimming Schemes – (Represented 20.8% of the total frequency of fraud schemes, conducted on small businesses with fewer than 100 employees in 2008.) This type of fraud consist of employees stealing unrecorded sales. Usually the culprits are cashiers, accounting employees, customer service agents, and managers. These employees have access to cash before it gets entered in the system. Cheapest limited liability company works best for a small startup.
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There are a few ways that this fraud is done by employees. However here are a few examples of this type of fraud:
- A cashier is selling a product or service, but the sales are not recorded in the register. Then the cashier takes the money from the customer, and personally keeps the cash.
- A salesperson sells 100 units of product at $5 each. However the salesperson only rings up 80 units of product at $5, then keeps the $100.
- An accountant issues phony receivables in order to cover up inventory thefts. Later, these receivables are written-off to hide the scheme.
Solution: Again you must have segregation of duties to prevent this problem. You should not allow one single employee to write checks, sign them, and then reconcile bank statements. In addition, in-coming mail should be opened by the business owner only. This will give an insight into any unusual accounting practices, if any. Most importantly, reviewing bank statements is an excellent way to determine where the cash is going. Also, inventory should always be checked and managed to ward against inventory thefts.
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There are many other schemes that are created every minute of the day and all over the world. However the schemes mentioned in this article are the most common. Personally, I believe that the best way to combat this problem is to think like a criminal. That’s right…think about a person who is intending to fraud you and how they would carry it out. Then, take preventative and corrective measures to prevent this from happening. Also, consider forming a private LLC.
Also, always remember that fraudsters aren’t always the obvious suspects. Meaning, most of these crimes are committed by your trusted employee who has been with the company for many years. If the employee has a pressing financial need, the means to carry it out, and the opportunity, the stakes can become very high and your business can be at great risk. Therefore by following consistent internal controls, many small businesses can prevent these costly frauds from occurring.