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Financial Consulting

Detecting Business Fraud

By Maurie Cashman

Business fraud isn’t as rare as you might think. Two companies that have experienced fraud losses have approached me this month alone. It’s important that you know how to prevent and deal with fraud if it comes your way.

From hourly employees skimming the cash register to top executives fudging their revenue numbers, fraud is an unfortunate fixture of the business landscape. However, while fraud may be a constant concern, falling victim to it isn’t inevitable.

Experience is a hard teacher because she gives the test first, the lesson afterward.” Vern Law

Employees and customers are just a few people who might take advantage of your small business. Here are some red flags that experienced forensic accountants look for, and advice for ways to ferret out and prevent wrongdoing.Small businesses with less than 100 employees experience a median loss of $154,000 due to fraud, according to the Association of Certified Fraud Examiners (ACFE). This number is higher for small businesses than most large companies.

Living Beyond Means

Signs that employees are living well beyond their means can be an initial clue that they’re helping themselves to the company’s assets.

Want to avoid being the victim of this type of fraud? Make sure there’s not just one person in charge of payroll or purchasing and reconciling the books.

Make it clear that routine audits and inspections of expenditures will occur. Just knowing they could be caught is enough to shut down many employee thefts.

“Send a signal to people inside the company that someone is checking.

Unusual Email

Emails that are out of character for the sender, or with directives outside the company’s normal practices, could be another sign that fraud is underway.

An example is a case where the email account of a business’s CFO was hacked, unbeknownst to anyone. The company’s controller received an email from the CFO’s account requesting several hundred thousand dollars be wired to a foreign bank.

The large sum and the request to send money to a country the company doesn’t do business in gave the company controller pause. She delayed filling the request and asked the CFO directly if the transaction was legitimate. It wasn’t, and the transaction never went through.

In this case, a transaction that was an aberration from normal procedures was a red flag that was picked up in time.

Being aware of inconsistencies and noticing emails written differently from how the sender normally communicates could help thwart online fraud schemes.

Loose Controls

Another red flag that fraud could be afoot is significant staff resistance to tighter controls.

When employees are used to skimming off the top, whether it’s an unsecured cash register or an open supply closet loaded with pricey items, companies might experience significant losses.

A golf club installed a new keypad on a gas tank employees used to fuel company maintenance vehicles. The keypad required staff to enter individualized codes each time they filled up.

There were grumblings from staff about the new system, and within a few months the club noticed gas costs dropped by nearly a third under the new system. It turned out that golf club employees had been filling their personal vehicles at the pump and driving off with the company’s assets almost every day.

Small to midsize companies can easily be targets of this type of asset fraud, especially businesses that have grown quickly and haven’t taken time to scrutinize their processes.

“A lot of times they’re more susceptible because fraud’s not on the foremost of their minds,” Richards said.

Sit down with their CPAs and evaluate internal controls closely to make sure best practices are in place.


Overly close relationships between employees in key purchasing positions and vendors could be a sign of a kickback scheme at work.

In kickback scenarios, an employee inside the company can have a deal with a friend, family member, or just a vendor he or she has gotten to know to overcharge the company. The vendor gets more cash from the company, and the insider gets a kickback as a reward.

This can be the toughest type of fraud to uncover, because the fraud is happening outside of the company’s sight. The company’s records simply show a purchase, not that the company paid twice what it should have.

Adopting purchasing policies to obtain several bids for large purchases can help minimize the risk associated with vendor kickback schemes. Contracts with vendors should also be reviewed.

This is also where internal whistleblower hotlines or a company culture that emphasizes the need to speak up when something is amiss can also help. It’s rare that internal controls, management review, internal audits, or external auditors uncover fraud. Statistics show most fraud schemes are discovered because of tips or whistleblowers.

Exceptional Performance

Another red flag to look out for is when things seem to be too good to be true, from startups reporting profit margins well above competitors’ to sales forecasts way above the norm. Companies that are always exceeding analyst expectations — pulling in 15% profit margins while competitors see no more than 5% — may deserve some scrutiny. There could be some unique, even illegal, accounting moves behind the success.

Drilling down and asking for specifics, or for an outside forensic accountant to comb the books, can help uncover this high-level fraud.

However, clean audit opinions alone shouldn’t assure boards, investors, and managements that all is OK. An audit is not a gold standard that fraud isn’t present. Audits, after all, are only as good as the information provided. If a corporate officer is participating in a fraudulent scheme, and smart enough to know how to clean up his tracks, the wrongdoing may not be detected as part of a properly planned and executed audit engagement performed by an independent accounting firm.

Payroll Theft

Payroll schemes are twice as common in small businesses as opposed to large companies, according to the ACFE. There are a few different ways that payroll fraud can occur at your business.

Have a separate payroll account so that potential fraudsters have access to a limited amount of funds. You only deposit enough money to cover employee paychecks with a payroll account.

You might also consider paying employees via direct deposit instead of paychecks. With direct deposit, you put the employee’s wages directly into their account. That way, you do not need to pass out checks with sensitive information. Some states allow employers to enforce mandatory direct deposit.

Employees might ask for pay advances without paying them back. Employees might lie about hours worked on their timesheets. Employees could also get co-workers to clock in for them even if they aren’t at work.

Do background checks on all employees before you hire them. Audit payroll accounts so you can catch fraudulent behavior early on.

Workers’ Compensation Fraud

There are different ways workers’ compensation fraud can occur, so you need to be vigilant. Employees might get injured outside of work and say they got the injury at your business, or employees could make up an illness or injury.

I once had an employee that filed a claim stating that he had injured his back by slipping in our plant. He was able to document this with a doctors’ note. One day we were doing customer calls and happened to run across the employee baling hay. He was on the rack loading bales about eight feet high.

How do you protect your business from workers’ compensation fraud? You need to document everything, keep accurate records, and look out for signs of fake injuries.

Fraudulent Numbers Are Frequently Round Numbers.

Rounding to the nearest thousand or million dollars in financial statements, or to the nearest penny in earnings-per-share calculations, is done to make it easier for investors and other interested parties to focus on the important parts of the numbers. Transaction amounts or ledger balances that are exact multiples of $1,000 or $1,000,000 may signal fraudulent activity.

An analysis of round number transactions or balances is complicated by the fact that the round number universe includes legitimate and authentic transactions and balances. Round numbers are often linked to the purchase of goods or services with individual and unique features; used property, plant, and equipment purchases; and charitable or political campaign contributions. Precise numbers (such as $1,279.85) are often linked to the purchase of mass-produced items and amounts that are a result of a calculation (such as a property or income tax refund that includes interest). Legitimate entries may certainly be round amounts. The challenge is to identify the fraudulent amounts that are the proverbial needles in a haystack, except that the fraud needles look similar to the hay.

Misstated financials could be achieved with just 10 intentionally erroneous round number journal entries out of 2,000 valid round number transactions.

The more internal controls and best practices are in place, the harder it will be for fraudulent schemes to grab a foothold.

Study these fraud identifiers and begin watching for the signs in your business. If you are suspicious, it would be wise to contact a trusted advisor to take a closer look.