Business Accounting

5 Hidden Signs of Fraud in a Small Business

2020-05-12 | by Gene B. Reynolds, CPA

This year’s workplace disruption has created a challenging situation for small business owners to support business integrity. One area of concern is being able to detect hidden signs of fraud in business activity, particularly when employees are working from home.

While many employees will work with integrity no matter their work environment, other employees may be able to start or continue fraudulent activity when not receiving in-person supervision. This is especially the case if there is a lack of internal controls or separation of duties.

According to the recent ACFE Report to the Nations on Occupational Fraud and Abuse, small businesses are most susceptible to fraud because they typically have fewer anti-fraud controls than larger organizations, leaving them more vulnerable.

We know it may be challenging for small businesses to take the necessary steps to prevent fraud due to limitations from available resources, staffing, time, or technology. To help, we put together the following information on the hidden signs of fraud that could help you maximize your time taking the necessary steps to identify and address fraud.

Consider Whether Fraud is Just Out of Sight

The following five examples capture the different types of schemes or instances of fraud that could be hiding just out of sight of a small business owner.

1. Bank Statement Modifications

Problem: Many small businesses are susceptible to fraud from their accounting department, especially when bank statements or other financial records bypass the owner directly to Accounting.

If there is a lack of segregation of duties — such as the same person receiving and reconciling financial statements — this introduces the possibility of fraud. A person could conceivably go through statements and modify the documents to cover for fraud and continue the scheme.

• ACFE Report: The department with the highest level of fraud is Accounting (14%).

Solution: Owners should set up a process where bank statements and financial documents are sent to them before Accounting sees the documents. This way, you have a record of the statements before the accounting department reconciles balances.

You may also consider performing a random review of transactions. We recommend reviewing the general ledger or online bank statements to identify transactions that don’t look or feel correct.

2. Fake Invoices

Problem: A fraudster in your company may create a scheme where they create fake invoices to pay “vendors” they create in the software system. These payments are then linked to their own personal bank account to receive deposits.

A small business owner may never see the payment because it’s coded very similarly to a legit invoice payment for a legit vendor. Or, the payment is so small that it’s never seen because it’s a small blip on the radar.

• ACFE Report: Internal Control weakness led to nearly 50% of fraud.

Solution: This type of scheme is usually hidden from the sight of the owner. If you, a manager, or another employee suspects that something is off with payments to vendors, then have your team review a batch of transactions to identify red flags.

To prevent this from happening in the future, consider a thorough review of how transactions are handled internally. Consider implementing internal controls that separate duties such as billing, reconciliations, and payment aging. This can help sniff out the presence of false customers being invoiced and the creation of false payments.

3. Incremental Increases in Orders

Problem: Employee fraud typically starts out small. It could be as simple as an employee walking out with office supplies, taking tools home, or taking other company property in small increments.

Then, if this continues to grow and extends over a prolonged period of time, the employee might feel the need to make incremental increases in budget requests, purchase orders, or other expenditures to cover for their theft.

• ACFE Report: Only 4% of fraudsters had a prior fraud conviction, capturing the prevalence of first-time fraud.

Solution: In addition to beefing up basic inventory control, you may need to consider implementing checkout procedures, especially if tools or other essential supplies continue to disappear. You don’t want to create a giant monster that turns into micromanagement, but owners should focus on taking small steps to make the company less susceptible to incremental theft.

You may also consider communicating with employees that you are aware of supplies, tools, or other company property disappearing or not being available for use. State that you are aware of the issue and you will be looking into the issue. This could dissuade the employee from continuing with the fraud.

4. Living Outside of Means

Problem: In most fraud cases, it’s a first-time person. Typically, the employee will convince themselves it’s okay to perform an action they know is wrong because they feel under-appreciated or underpaid. Or, they could feel pressure outside of work to find other sources of revenue.

In many cases, the way fraud is detected is someone is living above their lifestyle. They could be driving a new vehicle that does not seem to fit their pay range or could be talking to other employees about a lavish vacation that does not seem to fit their means.

• ACFE Report: In 41% of fraud cases, living beyond their means was the primary red flag indicating fraud.

Solution: While we do not recommend violating workplace regulations by asking inappropriate questions of your employee, we recommend keeping your antenna up to consider hidden clues that could indicate the possibility of fraud.

If you believe there could be the presence of fraud, then consider personally monitoring their workplace behavior or instructing their manager to monitor the employee’s activity to see if you can detect a pattern of irregular activity.

5. Delaying Vacation

Problem: If an employee starts to postpone or cancel their vacation, this could be a hidden sign that they want to protect their scheme. This person could have a complicated scheme that requires them to actively monitor their routine activity and the activity of others to continue the scheme.

• ACFE Report: The median duration of a fraud scheme is 16 months until detection.

Solution: If an employee continues to delay time away from work, then consider encouraging the employee to take their vacation. Then, have their manager or other employees check behind them while they are away to see if there are red flags in routine processes.

Talk to Our CPA Firm About Supporting Internal Controls

For some small business owners, the challenge is being able to detect fraud in your business. For others, it’s not having the resources to implement internal controls or separate duties once fraud is detected, especially during this year’s workplace disruption.

We would like to help your small business in this area. We can help your business set up internal controls, review which employees are responsible for which duties, and talk about any red flags you have observed.

Talk to us about supporting your business to insulate your business against these hidden signs of fraud. Contact us through our website form, call 713-316-4560, or email info@reynoldscpafirm.com.

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