Internal fraud, also called occupational fraud, is defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the organization’s resources or assets.” Simply stated, this type of fraud occurs when an employee, manager, or executive commits fraud against his or her employer. Stories of debilitating fraud cases surface every year. Small businesses are not immune to fraud, they just do not always make the news. In fact, many cases are not even reported to the authorities. People of all walks of life are capable of being dishonest, and when they feel a sense of financial pressure, they are capable of defrauding even the people closest to them.
Small business owners sometimes disregard the need for effective internal controls to prevent or detect fraud because they often employ family, friends, and long-term staff whom they trust. But far too often, that trust proves to be misplaced and it is those closest to the owner who commit internal fraud for their personal gain.
Lacking simple internal controls can make committing internal fraud a breeze. According to the Association of Certified Fraud Examiners (ACFE), a lack of internal controls is the leading cause of fraud. There are some very feasible internal controls that all companies should implement to deny a potential perpetrator the opportunity. Here are just a few:
Segregation of duties: Do you have one person in your company who receives the cash/checks, who also records the incoming money in the books? Is this same person also able to write checks and take deposits to the bank? This concentration of incompatible responsibilities creates opportunity for an employee to skim from incoming funds and cover their tracks, leaving minimal risk they will ever be caught.
As a small business owner, if it is not possible to segregate certain duties you should at the very least insert yourself into the process. Even a periodic review of transactions after the fact can ensure that employees know that someone is looking and deter fraudulent activity. As a rule, one employee should not have the ability to complete an entire process on their own.
Implement mandatory vacation time: Many frauds have been discovered when the perpetrator is required to hand over their duties for a period of time, for example when they are on vacation. If someone else must take over the job, fraudulent transactions or errors in processing may be discovered. If you have employees who refuse to take a vacation, or refuse to share their duties, this could be a red flag for fraud.
Monitor company cards: Having only one person in control of issuing company credit cards, authorizing charges, and reconciling bank statements is another example of where owners/managers need to step in and help to mitigate risks for fraudulent purchases or any purchases that go against company policy. With a lack of oversight, it would be very easy for authorized card holders to make unauthorized purchases. Owners or managers should review monthly bank statements to ensure that all purchases are permitted.
Maintain a policy and procedures manual: Sometimes it is as easy as having written policies and procedures to deter a potential internal fraudster. This manual should document management’s ethics, values, and expectations of employees and descriptions of their duties. Having all employees sign an agreement to follow company policies and procedures is the first step to discouraging fraud and communicating to employees that company policies are to be taken seriously.
Follow strict hiring procedures: Conducting background checks on potential employees is not fool proof, but it is a good way to understand any prior history and allow you to make informed decisions about who you hire to your team.
Implementing these simple internal controls is a great start for any small business. However, simply writing them down on paper will not make them effective. Owners and managers must ensure those procedures are communicated, periodically updated, and enforced.
And one final note—employees are often most vulnerable to perpetrating internal fraud when they are experiencing personal financial hardships. Effective internal controls are a strong deterrent in those instances. Removing the ease—and the opportunity—to commit fraud could save your business from being the next story on the news.
To learn more about assessing your business’s risk for fraud and implementing the appropriate internal controls, give R&A a call.