Thursday, September 30, 2010

Small Business Fraud - 10 Tips to Avoid

Several of my financial consulting engagements were the result of fraud within a client's company.  The business owner saw "weird" trends in his financial statements or "my financial statements show a lot of profit, but I don't see the cash".  The most common method of finding fraud is a tip or complaint from an employee, vendor, customer or anonymous informant. The following list of practical fraud prevention tips designed to prevent fraud from occurring and has been compiled from a variety of sources.

  1. The first step in preventing employee fraud is letting employees know you're watching for it. Inform employees during employee orientation, training programs, memorandums, or other communication that fraud is not tolerated and let employees know what to do if they suspect fraud. 
  2.  Have checks and balances in place.  For small businesses the biggest issue is to separate the duties of receiving funds, writing checks, signing checks, and reconciling bank accounts. Having one employee responsible for all cash-related functions makes small businesses vulnerable to fraud.
  3.  Have the monthly bank statement delivered unopened to the owner, who should review it for unusual transactions such as declining deposits, unanticipated payment and deposit patterns, and unfamiliar payees. Owners should look for signatures or endorsements that look forged, missing checks, check numbers that are out of order, and checks where the payee listed does not match the name in the check register.
  4. Institute background checks on new employees, and notify job applicants that their backgrounds will be checked.  Check past employment, criminal convictions, references, and education and certifications.  Always get the written consent of candidates before doing research since many federal and state laws govern the gathering of such information.  This should be part of the application process.
  5. Make sure expenditures are approved. For every expense, have a manager and someone in accounting approve it. The supervisor will ensure that the expenses are valid, while accounting will run the math.
  6. Monitor cash and inventory areas In a retail situation, have security cameras monitor activity at registers and storage areas where inventory is kept. People are less likely to do it if someone is watching them.  Deploy fraud tracking systems for any online stores you operate.
  7.  Insist that employees take a vacation for at least one week every year and use that time to have the books reviewed for discrepancies.
  8.  Adopt a tip hot line or complaint-reporting mechanism that will enable employees, vendors, customers, or outside sources to report suspected fraud anonymously  without fear of reprisal. Because most employees are reluctant to report suspicious activity, using a third-party hot line offers a level of anonymity that an in-house hot line might not provide, making employees more likely to blow the whistle on fraudulent activity.
  9.  Conduct audits, especially a "fraud audit" instead of a "general audit" if you suspect fraud. Catching an employee off guard could be your best bet in discovering fraud. The key is that an employee generally doesn't know what's coming and won't have the time to change the records to hide the fraud. A surprise audit also can uncover duplicate invoice amounts and duplicate or sequential invoice numbers, both of which can be red flags for possible wrongdoing.
  10.  Have an accounting software program expert, do the initial set-up of the program. In my QuickBooks work, I have found that the audit trail feature was never activated.  Access to personnel and vendor master file records should be password protected and restricted by job function.  Computer systems should create an audit trail of all changes made to the vendor master file records, including an identification of those who made the changes.  Changes to vendor master file records should require supporting documentation and supervisory approval.
What good techniques can you suggest?

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