You’re running a small business. You work hard, averaging 60-hour weeks. You have several employees and that gives you some occasional time to take an afternoon off here and there. You trust your employees.
And then you uncover a fraud. One of your employees has been making cash sales when you weren’t there and not recording them. He/she kept the cash. Not only is this a monetary lose for you, it is a personal betrayal, and it hurts.
And yes, it can happen to you.
Surveys by the Association of Certified Fraud Examiner consistently show that the median dollar amount and frequency of fraud is larger in small businesses than in large businesses. It’s not hard to understand why this is. There is a high degree of employer/employee trust in a small business. You know your people and trust them.
Another factor is that small businesses lack the basic controls that are found in larger businesses. In larger businesses, one of the major controls is to segregate duties among employees. In a small business, with limited human resources, it’s not uncommon for a single employee to be solely responsible for completing multiple tasks in a critical process. Large business have internal auditors and an annual audit done by a CPA.
But you are a small 5-person shop; what can you do?
Before I get into that, I want to tell you about a concept I learned about early in my career—the concept of the “Fraud Triangle.” Back in the 1950s, Dr. Donald Cressey developed a theory regarding the predictability of a fraud occurring. He identified three factors:
Does the person have the opportunity to commit a fraud. Could they do it if they wanted to.
Is there a motivating factor such as extravagant lifestyle, substance abuse, excessive bills, etc.
The way the employees internalizes in their mind that it is OK. Such as “everyone is doing it,” “I am under paid,” “It’s just a loan I will pay it back,” etc.
The point of the Fraud Triangle is that depending on the degree of each factor, the possibility of fraud increases. And, if you have a high degree in all three, you are almost asking for the fraud to occur.
Two things you must do.
I look at ways to mitigate fraud in two ways. There are things you can do to prevent the fraud. And, there are also things you can do to detect it after it happens. You have to do both. Here’s what that looks like:
- Hire people you can trust. Take the time to know as much about them as possible. Talk to references. Remember the three factors of the fraud triangle. Don’t just hire the first person to come along.
- Verify cash at the start and the end of the day. Use a system that has employees log into the cash drawer so you can keep track of who was at the register.
- Have the bank statement sent to you. (This is critical.) Look at it. See anything unusual? If so, investigate. If your employees do a monthly bank reconciliation, review it.
- Review all credit and debit card statements. Review key data such as sales, daily cash receipts, inventory records, payroll amounts, bank account activity etc., that may help you identify problems that may exist. Question amounts/items that don’t look right.
- Keep your business and personal finances separate. Don’t co-mingle business and personal finances.
- Compare this year to last year. Especially look at the cash flow. If this year’s cash flow falls short of last year, investigate to find out why.
- You may want to keep certain data files password protected. Operate on a need-to-know basis.
- And most importantly, you must be involved. Proper oversight and review by you is an essential aspect of fraud prevention and detection. Be skeptical. Look at things objectively. Obviously, you can’t run your business constantly thinking that all your employees are crooks. But take off the rose-colored glasses, don’t look at things as if everyone is 100% honest and he/she would never commit a fraud.
I can show you 1,000s of cases where he/she did it.
Here’s one other thing I feel I must mention. Keep an eye on employee spending. Be attentive. If your employees are displaying an extravagant lifestyle—expensive vacations, high-end new car, constant array of new clothes, etc.—this may be a red flag.
Early in my career I was associated with a business and the bookkeeper was showing all these signs. It should have made us more attentive, but we weren’t. Sure enough, the bookkeeper was processing personal expenses into the business records and once we took a harder look, it was obvious.
I hope this helps you avoid a fraud in your business. I admire small business owners. You are the backbone of our economic system. You work hard and deserve to reap the rewards. Hopefully, you won’t have a fraud and you will be able to keep all your well-earned profits.
By: Richard Dumont
Having worked in bank management and as a CPA for years in the public sector, Dumont is currently the Director of Undergraduate Business Programs for Post University. He also holds the position of Program Manager of Accounting and Leadership for the University, previously serving as an Assistant Professor of Accounting. His course specialties include Auditing, Fraud Examination, Internal Auditing and Advanced Accounting.