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How to Spot the Red Flags for Employee Fraud

image for Bacho/Shutterstock
Bacho/Shutterstock
  • The risk of employee fraud is much higher for small businesses than it is corporations.
  • Asset misappropriation, vendor fraud, accounting fraud, data theft, bribery and corruption and payroll fraud are the most common types of occupational fraud.
  • Four components – opportunity, rationalization, pressure and capability – create an environment conducive to fraud. 

Owning a small business is, in some respects, an act of faith. One of the biggest leaps of faith you face when starting out is believing you've hired honest, trustworthy employees. When you trust your employees, it can be difficult to think the worst of them, even when there are red flags – circumstances or patterns that are out of the ordinary – alerting you to the contrary.

Here are some tips for how to spot the red flags of employee fraud.

If you have fewer than 100 employees, the risk of employee fraud is much higher than it is for larger corporations. In 2018, the Association of Certified Fraud Examiners (ACFE) published its Report to the Nations on Occupational Fraud and Abuse, the largest and most comprehensive study of occupational fraud to date. According to the small business section of the report, "small businesses lose almost twice as much per scheme to occupational fraud [compared to larger corporations]," and the "median loss for businesses with fewer than 100 employees is $200,000." [Interested in the right employee monitoring software for your small business? Check out our best picks.]

The most common types of occupational fraud are asset misappropriation, vendor fraud, accounting fraud, data theft, bribery and corruption, and payroll fraud.

If you suspect, or there are red flags indicating, fraudulent activity, employees in financial service positions – such as chief financial officer, accountant, bookkeeper and accounts receivable or accounts payable roles –  might be a good place to start your search. These employees have access to the information that can do lasting and irreparable damage to your company.

According to the National Association of Certified Valuators and Analysts, there are four common factors that create the ideal circumstances for fraud:

  1. Opportunity. Inadequate or ineffective internal controls provide the perfect opportunity for fraud. According to the ACFE, small businesses typically have fewer anti-fraud controls than larger organizations, leaving them more vulnerable to fraud.
  2. Rationalization. Fraudsters invent justifications to rationalize their actions.
  3. Pressure. External pressures, such as significant personal debt or credit problems, can  push someone to commit fraud.
  4. Capability. To successfully pull off a scheme, the employee has to have the patience, access and knowledge to succeed.

Here are five red flags to look out for:

  1. An employee's lifestyle suddenly doesn't match their salary. When an employee is suddenly living well beyond their means, that could be a sign of fraud.

  2. An employee is being secretive. If one of your employees is extremely reluctant to share their processes or to have someone review their work, that could be a sign of fraud.

  3. You've receive frequent tips or complaints about a certain employee. This might seem obvious, but according to the ACFE, 29% of fraud in businesses with fewer than 100 employees is detected as a result of tips.

  4. There have been many inconsistencies in accounts receivable. Excessive or unexplained cash transactions; unreconciled bank account statements; an unusual increase in expenses, supplies or employee reimbursements; or sudden activity in previously inactive accounts can point to fraud.

  5. An employee thinks the rules don't apply to them. If you have the necessary internal controls in place but an employee refuses to follow proper procedures or adhere to regulations, this can be a red flag for fraud.

Fraud can cause long-lasting, devastating effects for any business, but the repercussions can be even more severe for small businesses. Because small businesses typically have fewer resources to dedicate to preventing and recovering from fraud, it's crucial for small business owners to not only be on the lookout for red flags but also act on them. More importantly, small businesses need to allocate resources to creating and enforcing proper internal controls to prevent fraud from happening in the first place.

Employee fraud comes in a variety of forms. Without looking for red flags, you won't even see it coming. Here are some common types of employee fraud:

  • Theft: This happens any time an employee steals money, property or resources from your business.
  • Embezzlement: This occurs when the accountants in charge of your money are stealing it.
  • Kickbacks/bribery: This is when employees accept money in exchange for preferred treatment.
  • Benefits fraud: This occurs when employees defraud company benefits, using sick days while healthy.
  • Payroll fraud: Employees also may steal time by illegally adjusting timesheets to show that they're present when they're actually absent.

This is just a small list of employee fraud types; be on the lookout for any type of employee fraud.

The risk of employee fraud is massive. Employees have keys to your business. Using their logins, they can create chaos by deleting important files, ruining customer relationships and ultimately putting your organization out of business.

You can lower the risk of employee fraud by using access control and monitoring protocols. Every process, especially those involving money, should have checks and balances in place to identify and prevent fraud. By proactively identifying fraud, you'll be in a better position as a company.