Have you ever thought: Corporate fraud won’t happen to me; it only victimizes the Targets or Home Depots of the world? No matter your industry or company size, you’re susceptible to fraud from your partners, other owners, employees, vendors, suppliers, customers, third-party companies or individuals.
Large companies may capture the headlines, but small and midsize businesses are especially prone to targeting. They tend to lack a sophisticated control structure and rely heavily on key individuals, putting them at risk for occupational fraud. And everyone is at risk for identity and trade secret theft, or billing schemes for services that were never provided or faulty/false goods.
“Telling businesses about fraud risk can be like trying to sell waterproofing for basements when people don’t see the water coming in,” says Lewis Baum, director and a certified fraud examiner at SS&G Parkland. “They think the problems and issues affect their competition and other companies — not their business, and certainly not a key employee who has been at the company for 25 years and never missed a day.”
But what if there’s a reason a trusted employee never takes vacation?
Smart Business spoke with Baum about corporate fraud and how to prepare and protect your business.
What’s the cost of fraud and how far does it go beyond the obvious financial loss?
When fraud occurs, depending upon its nature, the repercussions vary. An average organization loses around 5 or 6 percent of sales to fraud. If you have a business with a 10 percent profit margin and there is a $100,000 fraud, it needs to reproduce $1 million in sales to make up the loss. That can be a difficult endeavor for a small or midsize business.
With digital hacks and identity theft, you must deal with blows to your reputation and customers who feel their trust has been violated. Occupational fraud is not as much about reputation, but it can become a financial drain. In either case, there is a headache factor. Fraud takes energy out of management.
And the effects can ripple out with opportunity cost. If you lose profitability because of fraud, it’s profitability that could have been used for shareholder distributions, employee pay raises or investing back into the business to sustain growth.
What red flags can a company watch for?
Red flags vary based upon the type of fraud, but there are some general warning signs. You should watch the bank account information and activity, including reconciliations and credit card activity. In addition, you may have a problem if there’s an unexplained lack of cash flow or profitability. Monitor customer complaints and have a good sense of what services are being provided to the company.
A lot of fraud occurs when the president and/or owner relies on the controller, CFO or bookkeeper for all of the accounting functions. ‘I’m a sales guy. I have the relationships to build the business. I’ll hire someone to deal with the books and records.’ That absenteeism and lack of oversight is a breeding ground for potential problems.
There is a human factor as well. Profiling has gotten a bad name, but it can make sense from a fraud prevention perspective. Keep your eyes open for unexpected changes in lifestyle or someone going through dramatic life changes — a bitter divorce, unexpected medical problems. If the wife shows up wearing fancy jewelry or driving a Jaguar, yet the husband is making $30,000, it doesn’t add up. It may be explainable — Uncle Joe died and left his estate to them — but you still need to be cognizant of the discrepancy and question what’s going on.
How else can a company protect itself?
Fraud cannot, in its entirety, be prevented. At best you can deter and reduce fraud from happening, but it’s always going to be out there. Companies that take fraud seriously provide education and have a fraud hotline that they publicize to employees, customers and vendors. They ensure the workforce and management understand their roles, responsibilities and fraud risks.
You really need to be on top of your game and know what’s happening out there. That’s why it also makes sense to reach out to your consultants and service providers who have a better sense of the fraud trends and risks — use them as part of your education.
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