Preventing Fraud in a Small Business

Cost-saving measures are always attractive to businesses. If a company with annual revenue of $10 million could eliminate a $500,000 expense, would management be interested? Internal fraud prevention could be the key to saving money in precisely this way.

Experts estimate that companies lose about 5% of their revenue each year to fraud committed by employees. Of course, this is just an estimate, as we have no idea how much fraud goes undetected. But assuming the experts are right, 5% could be substantial. Some companies have such thin profit margins that 5% could be their profit for an entire year. (And the 5% loss figure doesn’t even include all of the secondary costs that go along with internal frauds, such as personnel costs, investigative costs, and legal fees!)

The key to preventing internal fraud is proactive fraud prevention techniques. Fraud prevention is not about putting out fires as they spring up. True prevention is about fire-proofing a company to eliminate the risk of fire. So measures must be taken in advance to prevent problems down the road.

A full-blown fraud prevention program is the best way to protect the company’s assets. But what if you’re a small company? A comprehensive program is probably not affordable or practical. It gets expensive, of course. And small companies may not have the personnel to dedicate to a fraud prevention program.

However, a few basic procedures can go a long way toward preventing internal fraud. These procedures are relatively inexpensive, while still providing a fair level of protection against fraud by your employees. Here are three recommended steps for small businesses:

Step One: Companies must hire the right employees. This can be easily accomplished with background checks, reference checks, employment verification, and credential verification. It is surprising how often a reference check or employment verification yields valuable information that disqualifies a candidate.

While some former employers are reluctant to provide information because of the fear of lawsuits, many will give direct or indirect information about a former employee. Some may say that they would not rehire the employee if given the chance. Others may be more direct and say that the employee was fired for theft. These clues, both small and large, can help companies avoid problem employees.

Step Two: Implement policies and procedures specifically designed to prevent fraud. Businesses often refer to these policies and procedures as “internal controls,” but the traditional internal controls implemented by auditors and accountants sometimes do not have enough anti-fraud muscle behind them.

Additional procedures that prevent fraud should be implemented, and these would include new authorization levels, separation of critical duties, and oversight of vulnerable areas. The involvement of anti-fraud professional such as a fraud investigator or forensic accountant can be very helpful in crafting and implementing controls.

Step 3: Educate employees. The most common way that internal fraud is detected is through tips from employees. Since employees can be such good watchdogs, it pays to educate them on the fraud schemes, signs of fraud, and how to report suspected fraud.

I’ve never met a business owner who is happy to have profits walk out the door unchecked. Proactive fraud prevention is a cost-effective way of stopping internal thefts. Even when budgets are tight, there are some easy (yet effective) actions that can be taken to reduce fraud in a meaningful way.

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