Small-Business Fraud

Be vigilant: undetected fraud can destroy your business.

According to the 2012 Report to the Nations on Occupational Fraud and Abuse of the U.S.-based Association of Certified Fraud Examiners, privately owned businesses with fewer than 100 employees are the most common victims of fraud; the most common type of fraud is the fraudulent billing scheme. According to the Association, between 40% and 50% of all victim organizations, no matter what their size, do not recover any of their losses.

Fraudulent Billing Schemes

False invoices are printed and presented using the name of a legitimate supplier but with a different address to direct the payment to a place where the fraudster can access the funds. Unfortunately, electronic payment systems make it possible to set up such accounts easily. Owner-managers may not pick up on the change because they only approve the invoice for payment and leave the actual electronic payment to the accounts payable clerk.

Payroll Fraud

The payroll cycle often provides the opportunity for a single employee or a conspiracy of two or three employees to misappropriate funds. For example, “ghost” employees can be added to the payroll. The payroll clerk sets up the ghost employee and deducts withholding taxes as required. But, instead of being remitted, the taxes are transferred to the fraudster’s personal account along with the net amount of the ghost employee’s pay. Payroll clerks have also been known to continue paying terminated employees.  Unapproved raises are sometimes given to these ghost or terminated employees. In fact, some non-existent employees have had entire “careers” before the fraudster was caught.

Cheque and Credit-Card Fraud

Never provide employees with unlimited credit cards or pre-sign blank cheques. Since fraudsters are often opportunistic thieves, such carelessness is an invitation to a would-be crook. You may be able to recover your losses, but your company is still out the cash or still indebted until you do.

The “Angel”

Owner-managed companies are often approached by shady “management consultants” with a proposal to review company operations, streamline them to save money and bring in more business. The process goes something like this:

• The consultants find serious operating issues. Cash flow, profit and loss projections indicate deficiencies and a negative outcome if operations are not changed.
• The consultants claim the looming negative outcome can be changed if they are hired for a couple of months and allowed to run operations. New cash flow projections incorporating the suggested changes show a very positive outcome.

For a hefty consulting fee, a management team appears, as do new clients.

1. Sales orders increase dramatically, production goes into overtime to meet the demand, inventory is shipped to the new accounts and accounts receivable skyrocket.
2. Cash flow starts to become an issue, but the management team’s presentation to the bank indicating increased sales and receivables convinces the bank to arrange a large increase in the operating line of credit.
3. More supplies are ordered, more production is scheduled, more sales and more receivables are booked.
4. Suddenly, the new customers are finding reasons for not paying within 30-60 days.
5. One morning the management consultants don’t show up.
6. Calls to the new clients demanding payments are ignored, or worse still, their phones are out of service.
7. Your business is in trouble.

Later on you find out that the new customers were not legitimate businesses but just a front. The consultants used your company and your leverage at the bank to manufacture the inventory, sell it to third parties for the best price they could get and leave you with bank debt and working capital problems.

Overordering

In this scenario, a fraudster buys excess supplies. After the order has been paid in full, some goods are returned. Reimbursement for the returned goods is deposited into a false account. A twist on this scam is to take credit instead of cash and apply the credit to the account.  Additional purchases are made using the company credit then sold at a discount to third parties.

Personnel Fraud

In addition to creating schemes to steal money from their employer, employees can cost their employer money in other ways.

Misrepresentation of Qualifications

All credentials and claims to experience should be checked out carefully before any employee is hired. Misrepresentation of qualifications such as a mechanic’s license, a university degree or professional designation, a license to operate heavy equipment or special vehicles can affect your business. If you hire someone with false qualifications, you could be putting yourself at risk for legal action if the employee causes an accident and breaches the terms of an insurance contract or violates provincial or federal regulations governing your business.

Abuse of Employee Privileges

Employees who abuse their privileges can also cost employers significant amounts of money over a year, for example, by:

• -taking a sick day to work at another job
• -abusing flex hours by not working the additional hours to make up for the time off
• -extending coffee/smoke breaks
• -showing up for work late every day
• -spending excessive amounts of work time on personal matters

Business Misrepresentation

Businesses can even misrepresent themselves through the creation of false data. If you are approaching another company for a merger or buyout, make sure their data is correct by exercising comprehensive due diligence on your target. It is worth hiring a forensic CPA to scrutinize both the target company as well as the business and personal histories of the principals. More than one potential buyer has been surprised to find senior personnel in the target company who have been bankrupt, done time in prison or have mob connections. Corporate data may be falsified in order to:

• -obtain increased operating lines of credit from a financial institution
• -inflate earnings to obtain additional investment capital or sell the company
• -hide operating losses or inventory write-downs
• -obtain bonuses in a performance-based incentive plan
• -cover up a fraud

Protecting against Fraud

A well-designed bookkeeping system to record transactions and produce financial records is your best protection against fraud. Bear in mind that a bookkeeping system without regular review provides little protection.

First Line of Defense

Take time to understand how your bookkeeping system works and review the results at least once a week. Comparing the financial data with the business of the week will help you find those unusual or unrecorded transactions. Such vigilance, combined with pointed questions to staff, will do much to convince individuals they cannot falsify information and get away with it.

Second Line of Defense

If you discover something suspicious and cannot resolve it internally, call your chartered professional accountant immediately.  Do not let any suspected fraud continue “until we find more evidence.”  First signs may give little indication of how much money or how m any people are involved. Delay will not only increase the losses but could also affect any later insurance claim or legal proceedings. Your CPA is impartial, knows business norms and understands your business.  Because small businesses tend to have fewer resources to spend on fraud prevention, they are more vulnerable; fraud can, however, have a greater proportional impact on a small company than on a large one. Talk to your CPA about the adequacy of your accounting controls.  In addition, observe those things that cannot be picked up by an audit, such as the employee who suddenly seems to be living beyond their means or exhibiting control issues concerning shared responsibilities.

Conclusion

Be vigilant!