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How to Spot the Red Flags for Employee Fraud

How to Spot Employee Fraud
Credit: Bacho/Shutterstock

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 red flags for employee fraud.

If you have fewer than 100 employees, the risk of employee fraud is exponentially higher than it is larger corporations. In April of this year, the Association of Certified Fraud Examiners (ACFE) published their Report to the Nations on Occupational Fraud and Abuse, the largest and most comprehensive study of occupational fraud to date. In their small business report, the ACFE states that "small businesses lose almost twice as much per scheme to occupational fraud [compared to larger corporations]" and that 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, which according to the ACFE occurs in 27 percent of businesses and lasts for an average of 36 months.

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

According to the National Association of Certified Valuators and Analysts, there are 4 common components 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.

Some red flags to look out for include:

  1. Employee lifestyle that suddenly doesn't match their salaries. When an employee is suddenly living well beyond their means, that could be a sign of fraud.
  2. Employees who don't use their sick or vacation days, frequently stay late or work on the weekends. 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. If you've received frequent tips or complaints about a certain employee. This might seem obvious, but according to the ACFE, 29 percent of fraud in businesses with fewer than 100 employees is detected as a result of tips.
  4. If there have been a large number of inconsistencies in accounts receivable. Excessive or unaccounted-for cash transactions; unreconciled bank account statements; an unusual increase in expenses, supplies, or employee reimbursements; or sudden activity in previously inactive accounts can all point to fraud.
  5. Employees who feel as though 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 much more so for small businesses. Because they typically have fewer resources to dedicate to prevent and recover from fraud, it's crucial for small business owners to not only be on the lookout for red flags but also to act on them. More importantly, small businesses need to allocate resources to create and enforce proper internal controls that can prevent fraud from happening in the first place.

Julianna Lopez

Julianna Lopez is a freelance writer, editor, and social media marketer. She loves all things New York, books, movies and theater. If you're interested in her services, you can reach her at lopez.julianna6@gmail.com.