Top Five Fraud Risks in Small Business & How to Mitigate Them

Thoughtware Article Published: Sep 03, 2021
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According to the Association of Certified Fraud Examiners Report to the Nations 2020 Global Study on Occupational Fraud and Abuse, U.S. businesses will lose an average of 5 percent of their gross revenues to fraud. That’s more than $4.5 trillion lost to fraud globally each year! Furthermore, a typical case of fraud lasts 14 months before the fraud is even detected, causing an average of $8,300 in lost revenues per month. Ouch. The COVID-19 pandemic has caused additional concerns for small businesses, too. In fact, the U.S. Small Business Administration has published a report to help organizations protect themselves from grant fraud, loan fraud, and phishing. As a small business, losing any amount of revenue can be detrimental to your growth—or even your survival—so it’s important to prevent fraud within your company. Here’s how.

First off, it’s important to note there are four departments within an organization that account for more than half of all occupational fraud, so focusing your efforts on these key areas is a great starting place: operations (15 percent), accounting (14 percent), executive/upper management (12 percent), and sales (11 percent). You might be asking yourself, “What would cause someone within one of these departments of my organization to commit fraud in the first place?” There are actually three components that lead to fraudulent behavior.

Fraud Triangle Model

The fraud triangle model, developed by well-known criminologist Donald R. Cressey, consists of opportunity, pressure, and rationalization. Opportunity is a result of a lack of internal controls, no segregation of duties, or too much trust without much oversight. Pressure or motivation can be driven by debt, greed, lifestyle needs, illicit activities, pressure to perform, or too much work. Rationalization is a way for the person committing the fraud to justify the fraud.

Next, let’s look at the top five fraud risks that are most likely to affect small businesses:

  1. Corruption – This includes bribes from suppliers, giving discounts to friends and relatives, and selling sensitive information to competitors.
  2. Billing fraud – Billing fraud occurs when an employee submits fake, personal, or inflated invoices for goods or services to the employer. 
  3. Check and payment tampering schemes – These are schemes in which the employee steals company funds by forging, altering, or intercepting a check drawn on one of the company’s bank accounts.
  4. Payroll fraud – Employees or employers will wrongfully manipulate the payroll system to receive payment they haven’t earned. Examples include time sheet fraud, ghost employees, and worker misclassification.
  5. Cyber fraud – One common fraud among small businesses is phishing attacks. Phishing attacks lure the user into opening an email or attachment containing malware. As soon as the attachment is opened, the user’s data gets compromised.

Knowing this, what can you do to help mitigate these types of fraud? The good news is a lot of it is simple and cost effective to implement and within your control.

It should go without saying, but worth mentioning right out of the gate, that owners and upper management should act with integrity and honesty. Ethical leaders inspire their teams to act with integrity and lead by example. Aside from that, having a hotline in place and fraud training for employees, managers, and executives, as well as establishing an anti-fraud policy, can lower fraud losses and allow for quicker fraud detection. In fact, make it official and have the employees sign off, acknowledging their understanding of what’s expected of them within your company. Also, run background checks on potential new employees during the hiring process. But the most beneficial thing you can do is implement properly designed internal controls. This can be challenging for a small business that has limited resources, but not addressing internal control deficiencies can expose the business to financial and operational risks that can be prevented. More than one-third of frauds occurred because of a lack of internal controls. Some internal controls to consider implementing include:

  • Create monthly cash flow projections
  • Review your bank statements in detail every month
  • Prepare or review the monthly bank reconciliations
  • Review the company credit and debit card statements for accuracy
  • Review all outgoing payments
  • Require vendors to submit detailed invoices
  • Sign or generate check payments yourself
  • Review payroll 
  • Require employees involved with the business finances to take annual vacations, and have someone else handle their duties
  • Review your use of debt
  • Have inventory control systems in place
  • Monitor point-of-sale transactions

Another proactive measure to help mitigate fraud is to provide employee support programs to assist employees struggling with physical and emotional health issues, as well as family and/or financial problems. There are seven signs to watch for that could be indicators of employee fraudulent activity:

  1. Is the employee living beyond their means?
  2. Is the employee going through a divorce or having family problems? 
  3. Is the employee having financial difficulties?
  4. Does the employee have a wheeler-dealer attitude?
  5. Are there control issues? Is the employee unwilling to share duties?
  6. Has the employee been defensive, irritable, or acting suspicious?
  7. Does the employee have close associations with vendors or customers?

In today’s business environment, it’s more prudent than ever to understand how fraud can disrupt your organization and ways to help mitigate it. 

To find out how we can help your small business mitigate fraud, check out our Outsourced Accounting Services webpage and learn about the capabilities of our fraud investigation and prevention team. If you have questions about any of our services, connect with a BKD Trusted Advisor™ today by using the Contact Us form  below.

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