Early Signs of Fraud in Your Small Business

Natalia Autenrieth In her professional lives across the United States, Natalia Autenrieth, CPA has audited Fortune 500 clients as part of a Big 4 team, built an accounting department as a controller of a large hospital, and served as a CPA consultant to municipalities. Today, Natalia coaches in the financial industry and writes about business finance, financial technology, and personal money management. Her ghost-written articles have appeared in thought leadership and expert blogs, as well as Kiplinger and Accounting Today. Read more about Natalia and her practice at www.AutenriethAdvantage.com.

Early Signs of Fraud in Your Small Business

Small businesses are often run by a close-knit group of founders and employees. Long hours together and the shared burden of the daily operational challenges can inspire close personal relationships and trust. This camaraderie can create an atmosphere that many founders and early employees remember fondly for years.

Unfortunately, many small business owners find that trust can be misplaced. Any enterprise is at risk of fraud, and small businesses are no exception. Many offenders start small and have no prior history of larceny, theft, misrepresentation, etc. Combine that with a culture of trust, and you begin to see why small business fraud can be tough to catch early.

What can an owner do to protect the business? Here are five things to consider.

Know the red Flags

Most small business owners aren’t CPAs who have been formally trained to detect financial fraud. The good news is that formal training, while certainly helpful, isn’t required as a starting point. Anyone can research the tip-off signs that may point to the possibility of fraud. An employee suddenly living beyond his or her means could be an indication of a problem. A traumatic change in an employee’s financial circumstances such as a serious illness, divorce, addiction, etc. could cause the pressure to steal – even if the person had never committed a crime before. Learn the red flags and do your best to apply them objectively, even if you like or trust the person in question.

Know What’s Most Susceptible to Fraud

There are dozens of known fraud schemes, and creative criminals invent variations on the classics to avoid detection. However, it is possible to think through your business model and identify assets that represent the easiest targets for fraud. For most small business owners, cash is at the top of the list. If you work with small-sized and valuable inventory, those items could be at risk as well. By determining which aspects of your business involve the highest risk of fraud, you can exercise extra vigilance there.

Don’t Overlook Administrative Tasks

Running a business involves dozens of strategic and trivial decisions every day, and few business owners launch a coffee shop or a retail location because they enjoy the record-keeping that comes with it. As a result, it’s easy to let account reconciliations slide for yet another month. Don’t make this mistake! Remember that missing bank statements, accounts that go unreconciled for extended periods of time, and unexplained variances can point to a problem.

Inventory Discrepancies

Does it seem like you cannot keep certain items in stock, and yet the sales numbers aren’t matching up with the apparent demand? In cases of valuable inventory, employees could be stealing it to sell on the side. Alternatively, they could be making the sale and pocketing the cash with no sale record created in the process. Monitor your inventory purchases in relationship to reported sales (or incoming cash flow) and consider installing cameras to monitor back room and shop floor activity to deter wrongdoing.

Overly “helpful” Employees

Who doesn’t want an employee that goes above and beyond the formal job responsibilities to help out? While a capable and helpful jack-of-all-trades may be an entrepreneur’s dream, sometimes there is a problem lurking behind the facade. Be wary of offers to take over your supervisory responsibilities, such as bank statement reconciliation, check signing with a stamp signature, etc. If you are in a position to detect or prevent fraud through what you do, don’t be too eager to release those controls.

What Can You Do to Detect or Prevent Fraud?

In short, know possible problem areas and implement a strong set of controls. Remember that securing physical cash, while critical, isn’t the only measure you need. Regular account reconciliations, activity review, transaction authorization, and surprise inventory counts can be an effective means of preventing fraud (as well as detecting it if it does happen).

Finally, don’t allow a trust-based culture to get in the way of implementing reasonable checks and balances. Structure your days with sufficient time for supervision and review. Be strategic and careful about which tasks you delegate and remember that fraud awareness is a state that should never be switched “off”.