How Do You Avoid Internal Fraud?

When financial times are tough, employees do things they would not normally consider.  It is uncomfortable to think that your employees might be stealing from you, but it happens every day.  Fraud is increasing nationwide as financial difficulties put the squeeze on workers. At Autopaychecks we frequently have businesses come to us because someone internally has been stealing from them.  It is usually the bookkeeper. Many times the bookkeeper was given too much freedom and authority.

One way to safeguard your business is to get more “eyes” on the finances of your business.  Most people will not steal if they think they might get caught.  I know that sounds really simple, but it is very true.  In this article we will talk about how to safeguard your business from internal fraud (theft).  Most of the solutions are quite simple; and as the business owner, you just have to be disciplined enough to do them.  But your number one job will be to reduce opportunity.

“Separation of Duties” is one of the most critical steps to ensure your businesses’ safety.  There are three basic accounting actions that take place in every business:

  • Approval of Expenses – Who decides: “Yes, we are going to pay this bill.”
  • Posting of Transactions – Who records transactions in your accounting system?
  • Asset Custody – Who actually signs checks or moves cash?

These duties must be separated if at all possible.  It is easy to see that if one person has all three functions in their control, that person can commit fraud.  This can be hard in a small business environment due to the small number of staff. However, you must make the effort.  Separation of Duties is why many companies come to us to do their payroll; we give their company more “eyes” on deck.  Every business owner that reads this article either knows another owner who has been a fraud victim or has had it happen to them personally.  In 2008 roughly 7% of the businesses that came to us as new payroll clients, came because of an internal fraud event. None of these incidents were for less than $30,000.00 and all of them were from someone they thought of as part of the “business family.” 

Here are some simple solutions to help you and your company “separate duties.”

  • Approval of Expenses – As business owners can be distracted, many do not review their accounts payable or know all of their vendors. Many incidences of fraud happen when a trusted individual creates a “dummy” vendor and a bank account to deposit those checks. The “dummy” vendor will look like the kind your business would normally purchase from. For example; “Joe’s Landscaping” might have an “extra” bill for topsoil.  After a while the vendor looks like one of your regular suppliers. Also – open your own mail. Many fraudulent activities are hidden because the business owner does not see all of their mail – like payroll tax notices. Finally, review all bank statements and approve the bank reconciliations.
  • Posting Transactions in your Accounting System – If your employees periodically see you reviewing the accounting entries they will be much less likely to feel comfortable making a fraudulent entry. Do it openly so that it is common knowledge that you are on top of things. The other solution if you are too busy is to have regular audits done or have another employee review the entries. It is always more difficult (not impossible) to get two people cheat than it is for one.
  • Asset Custody – Make sure that the person who cuts the checks is not also the signer.  Or if you delegate this task, make it tougher by having two party checks that must have multiple signers. 

Here are a final few ideas to help prevent fraud:

  • Educate your employees as to what fraud is and what the penalties are.  Just having the conversation will be a deterrent to the crime.  Your staff needs to know you are paying attention.
  • Make sure you have employee dishonesty insurance.  This will help pay for the costs arising from internal fraud.
  • Employees most likely to commit fraud are not who you may think they are. A study by Edi Bailly in 2010 found that the most common age groups that committed fraud were between 40-49 and 50-59 years old and the amount stolen by the 50-59 years old was double that of the 40-49 year olds. And two thirds of those committing fraud were female! 

 So remember: Separate critical accounting functions, review your bank accounts regularly, open your own mail and make sure employees know that they are being watched – either by fellow employees or by you. Lastly, run background screening on all people you hire. It’s the cheapest insurance you can buy!