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5 Signs of Employee Fraud and How to Respond to Them

Adam Uzialko
Adam Uzialko
Editor
Business News Daily Staff
Updated Jun 29, 2022

Small businesses are at higher risk of employee fraud than large corporations are. Here's how to spot the signs that your employees aren't being honest.

  • The risk of employee fraud is much higher for small businesses than it is for large corporations.
  • Theft, embezzlement, bribery, benefits and payroll fraud are common types of occupational fraud.
  • Four elements – opportunity, rationalization, pressure and capability – create an environment conducive to fraud. 
  • This article is for small business owners and managers who want to learn how to identify and prevent employee fraud.

One of the biggest leaps of faith you make when starting a small business 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. Ignoring those red flags could be disastrous, though, so it’s important to learn how to identify them and root out fraud before it goes too far. Here are some tips for how to spot the red flags of employee fraud.

What is employee fraud, and how common is it?

Employee fraud occurs when an employee engages in fraudulent activity, such as stealing from or deceiving their employer, in order to extract some form of financial or personal benefit. 

Employee fraud is much more common than most business owners realize. PwC’s Global Economic Crime and Fraud Survey 2022 found that 46% of organizations reported that they had experienced fraud in the past 24 months. Most business owners think of external threats when they consider the risk of fraud, but 31% of the fraud reported in PwC’s study came from internal participants. An additional 26% resulted from collusion between internal parties and external actors. In other words, a total of 57% of the fraud incidents PwC examined occurred with the help of an employee.

How to spot employee fraud

Oftentimes, there are signs of ongoing employee fraud. 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 an employee is extremely reluctant to share their processes or to have someone review their work, that could be a sign of fraud.
  3. You’ve received frequent tips or complaints about a certain employee. This might seem obvious, but according to the ACFE, 42% of employee fraud cases are 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. Be sure to use an expense tracker to monitor the accuracy of employee reimbursements and regularly review your business’s accounting reports.
  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.

While many employers work to build trusting relationships with their employees, it’s OK to be skeptical if you start noticing these red flags. Catching employee fraud earlier can help minimize the impact on your business.

Did you know? Of the 42% of employee fraud cases discovered because of tips, half come from employees. Setting up a tip hotline can help you catch fraud earlier and minimize your losses.

What are the types of employee fraud?

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 – for example, by using sick days when they’re healthy.
  • Payroll fraud: Employees also may steal time by illegally adjusting timesheets to show that they’re present when they’re actually absent.

These are some common examples of employee fraud, but it may take other forms. Be on the lookout for other types of fraud, as scammers often find creative ways to exploit a business.

TipTip: Time theft is an increasingly common form of employee fraud that can be hard to catch if employees are working remotely. Invest in a good time tracking application to ensure that employees are not misrepresenting their hours.

Which businesses are at risk for employee fraud?

Businesses with fewer than 100 employees are at much higher risk for employee fraud than larger corporations are. The ACFE’s 2022 Report to the Nations on Occupational Fraud and Abuse, the largest and most comprehensive study of occupational fraud to date, found that organizations with the fewest employees had the highest median loss in employee fraud cases. Small businesses also struggle more heavily to recover from these losses compared with larger businesses.

Industry also affects risk. The industries with the highest risk for employee fraud include banking, real estate, healthcare and manufacturing. For-profit companies have the highest levels of employee fraud, followed by government entities and public agencies. Nonprofit agencies make up only 9% of employee fraud cases, making them the least at-risk.

Why does employee fraud happen?

If you suspect 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, four common factors create the ideal circumstances for fraud:

  1. Opportunity. Inadequate or ineffective internal controls provide the perfect opportunity for fraud. According to the Association of Certified Fraud Examiners (ACFE), small businesses typically have fewer anti-fraud controls than larger organizations do, 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.

How does employee fraud affect businesses?

Employee fraud can have huge costs for businesses, one of the biggest of which is the financial loss that can occur if employees steal products or funds from the business. According to the ACFE’s 2022 Report to the Nations on Occupational Fraud and Abuse, an employee fraud case costs a business an average of $8,300. Typically, these cases last an entire year before being detected and shut down. The costs of fraud add up quickly.

Fraud can have 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.

Key TakeawayKey takeaway: Small businesses are more susceptible to employee fraud, particularly as many of them do not have anti-fraud measures in place. Protect your business by staying diligent in detecting fraud and putting the proper checks and balances in place.

Proactively spotting employee fraud

The risk and repercussions of employee fraud are 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.

Kaylyn McKenna contributed to the writing and reporting in this article.

Image Credit:

Bacho/Shutterstock

Adam Uzialko
Adam Uzialko
Business News Daily Staff
Adam Uzialko is a writer and editor at business.com and Business News Daily. He has 7 years of professional experience with a focus on small businesses and startups. He has covered topics including digital marketing, SEO, business communications, and public policy. He has also written about emerging technologies and their intersection with business, including artificial intelligence, the Internet of Things, and blockchain.