Fraud can impact any business, small or large. Here's what you need to know to protect yours.
- Fraud can affect businesses of all sizes.
- All businesses should learn to identify the various types of fraud.
- There are several steps a business can take to prevent fraud.
Fraud is a serious issue that could bring down a company, no matter its size. According to research by the Association of Certified Fraud Examiners (ACFE), businesses lose an estimated 5% of their annual revenue as a result of fraud committed by employees, managers, owners and executives.
"Fraud detection and prevention should be an ongoing initiative," said Cynthia Hetherington, founder and president of the Hetherington Group, a consulting firm that focuses on intelligence, security and investigations. "[Businesses should] develop and review policies and controls to fight fraud and safeguard their livelihood from this continually growing problem."
What is business fraud?
Business fraud occurs when a person or a company commits dishonest and illegal acts that result in a financial gain for that person or organization. Business fraud can often be hidden and appear to be a legitimate business interaction.
Because fraud is such a monumental problem – so much so that it could even lead to the critical failure of an otherwise successful business – it's important to combat it vigorously. Research published in Harvard Business Review (HBR) suggests that those in the best position to fight fraud are employees.
To encourage employees to come forward when they are aware of fraudulent activities, companies should consider offering job protections, and even rewards, to whistleblowers. Unfortunately, firms engaged in fraud often offer incentives for employees to ignore the fraud instead, and these methods work.
"Misreporting firms that granted more stock options to rank-and-file employees were less likely to be exposed by a whistleblower," HBR researchers wrote. "Approximately 10% of the firms in our sample were subject to a whistleblowing allegation. Firms that avoided a whistleblower granted 78% more stock options than these firms did not."
Part of avoiding this vicious cycle in the first place is to build a culture of anti-fraud right from the start. Owners and managers should put together a list of anti-fraud policies in good faith that will govern the organization for years to come and, in the case the company goes public, be subject to shareholder review before being revised or rescinded.
Hetherington offered the following tips to help businesses protect themselves from fraud:
- Offer internal and external audits.
- Create management reviews and independent audit committees.
- Offer fraud training for management and employees.
- Have mandatory vacation and job rotation.
- Create a hotline or tip line and rewards for whistleblowers.
What are the different types of business fraud?
There are five major types of business fraud that could negatively impact your business:
Identity theft: A fraudster could steal the identity of your business and access your credit. Fraudsters may gain access to your federal tax ID or financial statements. They could take this information directly from your computer.
Payroll fraud: This may be more common with smaller business, but it can happen at companies of all sizes. Employees may ask for paycheck advances and not pay them back. They may also lie about hours they worked or have co-workers clock in and out for them. Utilizing a payroll service that lets you approve everyone's time before they are paid may help to prevent payroll fraud.
Fake money: Your business may receive fake money. There is more fake money in circulation than you probably realize. You should learn how to recognize fake money so you can refuse to accept it.
Returns: If your business deals with goods, you may have customers buy items, use them and return them even though there is nothing wrong with the items. Requiring a receipt and having strict return policies may help to limit return fraud.
- Workers' compensation: A business owner is required by law to purchase worker's compensation. This insurance pays your employees if they get injured while at work. Companies should stay on top of safety and what happens in your place of employment to help prevent this type of fraud. You should also make sure that if an employee states they were hurt at work, the injury really happened there.
Prevent fraud by hiring the right employees
Small businesses must be extra vigilant about fraud, Hetherington said.
"Small businesses, in particular, are extremely susceptible to employee fraud, as they often lack the anti-fraud controls or policies found in larger organizations," she said.
Hetherington offered the following tips for small businesses to start preventing fraud right from the hiring process.
1. Conduct a background check.
Small companies seldom bother doing background checks on new employees, which means they're potentially inviting hackers, predators and even convicted felons into the organization. Before hiring an employee, conduct a thorough background check that goes back seven years to see if there is a criminal history. [Looking for the best background check services? Check out our best picks.]
2. Run a credit report.
With a signed release, check new employees' credit reports for any fiscal irresponsibility, especially if they'll be working in any kind of financial role. During an economic crisis, it's OK to have some financial stresses, but you wouldn't want your comptroller to be filing for bankruptcy.
3. Do a social media audit.
Once the employee is being considered for hire, review their social networks for anything that could be damaging to your business's reputation, especially any animosity against their former employer.
4. Implement policies to protect your reputation.
Institute an employee policy that outlines expected employee behavior anytime they represent the company, including any mentions on their social networks.