Building a small business into a thriving, successful enterprise is a huge challenge. The last thing a budding business needs is to be the victim of fraud. No matter what size your business, fraud will cause it damage, sometimes to the point of putting you out of business. But there are ways to detect and prevent fraud.
Types of fraud
The business world has traditionally suffered from three main types of fraudOpens a new window : corruption and bribery, such as kickback and shell company schemes; fraud by employees who misappropriate company assets; and fraudulent reporting of financial status by management. In the latter case, stakeholders, investors and the public are all at danger of receiving misleading or inaccurate financial information.
Misappropriations of company assets often takes place without management’s knowledge. Employees typically are aware when management makes fraudulent financial reporting. Either way, the business can end in devastation.
Potential effects on business
Whether your business is losing money through the theft of petty cash funds, embezzlement or underreporting of income, your business could end up in a bindOpens a new window . These fraudulent activities decrease your ability to pay bills and order supplies and can prevent you from offering incentives to keep key employees.
Financial loss is an obvious ramification of fraud but there are others. Confirmation of a fraudulent incident can have a detrimental effect on your company’s reputation. A tarnished public image can be the death knell of a small business. This could increase the price the company pays for credit, could cost the company membership in trade associations or hinder the formation of strategic alliances.
A small business that is subject to audits may find itself designated a high risk on future audits if it has experienced an episode of fraud. If company management committed the fraud, auditors are more likely to give the company books much closer scrutiny before certifying financial statements. The cost of the audit will increase as well.
Fraud can have a devastating impact on a company’s morale and culture. It can be embarrassing for those who work there when the company perpetrated the fraud. Employees may fear repercussions and lose confidence in the stability of their jobs. They may feel betrayed if the fraud was a result of employee actions, especially if the company is a small business where employees tend to feel more connected to each other.
Preventing fraud in your business
Different types of fraud require different countermeasuresOpens a new window to prevent them from occurring. A breakdown of the three main types of fraud, along with suggested strategies to combat them, follows.
Fraud type: corruption and bribery
Corruption schemes occur when employees use their positions and influence for their own benefit. The best way to combat this type of fraud is to know your employees and fully vet them before bringing them on board.
• Observe and listen to employees for indications of potential risks involving corruption or bribery.
• Fully investigate any incidents of reported misbehavior among employees, especially those involving women and their superiors.
• Management must make time to get to know employees; this is one of the easiest ways to detect brewing areas of discontent that could lead to fraud committed for revengeful purposes.
Fraud type: misappropriation of company assets
Safeguard your company’s assets by instituting internal control plansOpens a new window . These are the programs you implement to ensure the integrity of your accounting practices and deter and detect fraud and theft.
• Segregating employee duties is one internal control that can reduce the risk of fraud, even in small business settings. For example, have one employee tally the receipts while another completes the deposit slip. A third employee should then make the actual deposit.
• Documentation creates an internal control that can reduce fraud.
• Number all transaction documentation sequentially; checks, purchase orders and invoices all numbered consecutively makes fraud more difficult.
• Avoid using signature stamps and require two signatures on checks above a certain amount.
• Do a credit check or background check (or both) on new employees before accepting them for employment.
• Be aware of new vendor accounts opened and do a credit check, local Chamber of Commerce inquiry or Better Business Bureau check on them.
• Monitor and evaluate your internal control policies and programs. Hire a professional with experience in the field if you’re unsure of your own ability to detect and prevent fraud.
• Maintain a positive work environment. Satisfied employees are less likely to commit fraud than disgruntled ones.
• Your business should have a clear organizational structure, written policies and proceduresOpens a new window and adhere to fair employment practices.
Fraud type: fraudulent financial reporting
To prevent this type of fraud, education must take place at the management levelOpens a new window . The company expectations on the part of management must be every bit, if not more, stringent as those required of employees.
• Educate management to look for red flags that could indicate fraud.
• Any internal control policy or program must include segregation of accounting functions. Separate the functions of recordkeeping, authorization and accounting review processes.
• More than one person should be responsible for the preparation of financial statements.
• One of the strongest deterrents to fraud is a management team that expects and demonstrates ethical behavior.
• Have yearly examinations of financial statements by an independent outside third-party. Increase the frequency of these examinations as needed.
• Hire a professional auditor to perform a review of your financial statements before releasing or publishing them.
• Engage outside auditors or auditing firms to perform unscheduled audits. This can go a long way in preventing employees from presenting incorrect financial statements intentionally.
Fraud can destroy a business, but businesses can prevent this from happening by practicing these common-sense strategies.