The most important books to scrutinize: your own

As certified fraud examiners, we have experience analyzing the books of not just public companies but also many private concerns, especially when it comes to tracking down fraud and theft.

As an advisor running your own small business, it’s worth knowing the potential risks of occupational fraud, defined as someone using their position to steal—possibly from you.

Even if you aren’t concerned for your own practice, you might have small business owners among your clientele, and it’s worth counselling them on how to protect themselves from fraudsters.

In its 2018 “Report to the Nations,” the Association of Certified Fraud Examiners lays out a dizzying array of facts about frauds around the world, collected by members who provide information on cases they’ve uncovered.

According to the report, frauds that occur in small businesses have different roots from those in governments and large enterprises, where corruption schemes, such as bribery, tend to be the most common cause.

In small businesses, frauds are more likely to occur through billing schemes, cheque and payment tampering, expense reimbursements, payroll frauds and cash skimming.

Small businesses also experience higher losses per incident. The median loss per fraud scheme in small enterprises was US$200,000, versus US$104,000 at their larger counterparts. This is likely the result of fewer checks and controls. As the report notes, small businesses “require an increased level of trust in employees due to a lower ability to implement robust anti-fraud controls.”

Indeed, 42% of fraud cases involving small businesses were caused by lack of internal controls. This was the cause in only 25% of frauds at large organizations, which tend to benefit from counteractive measures such as tip lines, whistleblower awards, management fraud training and proactive data analysis.

The report lists more than a dozen checks and balances but, in our experience, entities employing fewer than 50 people should focus on the following key measures to reduce fraud.

Requiring job rotations or mandatory vacation time for critical bookkeeping positions will reduce or eliminate the temptation for fraud (barring collusion among parties). Separating the roles of expense approval, payment processing and reconciliation can cut the fraud chain.

Surprise audits also help. According to the report, the median loss due to fraud was reduced by 51% when surprise audits were present, likely due to the median duration of the scheme being cut by from 24 months to 11 months.

We should note that surprise audits are different from audits of external financial statements, with the latter actually having one of the lowest rates of effectiveness in reducing loss.

Perhaps the biggest mistake owners can make is trusting the wrong employees, or assuming that people who have been with them longest are the most trustworthy. Signs of loyalty can be mistaken when the actual dedication is to the fraud and not the organization.

The ACFE report notes that fraudsters with more than five years’ tenure with their company stole twice as much. Owners shouldn’t assume there’s nothing nefarious occurring simply because everything seems fine. We investigated one fraud that lasted almost 25 years before being uncovered, and then only through a change of ownership.

Small business operators should know that employees in accounting are most likely to commit fraud. But in addition to job function and lack of controls, behavioural traits are good indicators.

The report highlights the most common behavioral characteristics of those who commit fraud: people living beyond their means, experiencing financial difficulties or dealing with a recent divorce or family problems; employees with unusually close association to a vendor or customer; people with excessive control issues or unwillingness to share duties; and, lastly, those with a wheeler-dealer attitude that includes unscrupulous behaviour.

While your small business clients might not welcome another task when already running a demanding practice, remind them that, according to the study, the majority of victims did not recover any money lost to fraud. Preventative measures are the best policy.