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  • Writer's pictureLuke Templin

Financial Fraud: The $117k Bombshell Sitting in Your Small Business

Updated: Dec 22, 2023

This article was originally written for my column for Inc. Maginize.

Financial Fraud: How to prevent fraud in business

The most common and costly fraud plaguing business owners is employees stealing from the company. Did you know the median loss for these fraud cases is $150,000 for small businesses with less than 100 employees?

For small business owners, this could be a significant blow, and many businesses are at risk--not from outside threats but from their employees. Many of these cases stem from small businesses putting too much trust in just one person. One trusted bookkeeper may seem cost-effective, but it also places you at risk. An experienced Chief Financial Officer ("CFO") I know stepped into a multi-million dollar manufacturing company where the owner trusted his wife to do the books. The CFO found the wife had stolen over five figures from her husband's business. The lost funds were unrecoverable, but the CFO established processes to prevent future fraud.

I'm a former certified fraud examiner who has been advising entrepreneurs as a CFO for nearly a decade. Unfortunately, there is no guaranteed way to prevent fraud one hundred percent in your business, but these five tips will help reduce the likelihood of fraud and lead to quicker detection:

1. Create a fraud reporting program.

The ACFE found in their Occupational Fraud Report that tips are the most common way fraud is detected in businesses, as they have been in every report they have done. The ACFE also found that fraud losses are 2X higher and take six months longer to detect without a reporting mechanism like a hotline.

Hotlines allow employees of your company to submit anonymous information about potential fraud. There are many third-party solutions to try, but having a true hotline in a small business might not be feasible for some.

An alternative solution for small businesses is creating an anonymous survey or an open-door policy that makes employees feel safe reporting potential fraud. Either of these solutions is more cost-effective than a hotline and accomplishes the same result.

Education is vital regardless of the solution your company uses for fraud tips. The best reporting system will fail if employees do not know how to report fraud.

2. Rotate jobs.

The ACFE found that fraud damages were reduced by 54 percent and detected eight months sooner with job rotations or mandatory vacation.

Job rotation plays right into the documenting processes tip below. Documenting processes helps you identify potential weaknesses in your processes and makes job rotation easier.

I approach job rotation in my consulting business as follows:

  • The main person performing the role creates and maintains the process documentation. We use a combination of recorded videos and written steps.

  • The person who created the documentation performs the tasks for a few months to hone the documentation.

  • Then, I have someone else do the tasks using the documentation for a few months.

  • The new person performing the tasks updates any documentation they feel needs clarification.

This process allows your company to reduce the likelihood of fraud and train someone else to step into a role when the other person is out. You can take it one step further by requiring employees to take mandatory vacations, which can be challenging in a small business.

3. Proactively monitor and analyze data.

The ACFE found that fraud damages were reduced by 47 percent and detected ten months sooner with proactive data monitoring and analysis. Paying attention to financial data and asking questions throughout the month will make your bookkeeper aware that you are paying attention.

Most business owners only look at their income statement, but you must take your analysis further. Here is a non-exhaustive list of items to analyze:

  • Reconciliations and statements

  • Balance Sheet

  • Cash Flow Statement

  • Vendor payment summary

Drilling down into these reports and asking questions is critical to reducing fraud. You also need to be doing this proactively.

In our experience, entrepreneurs are reviewing financials, at best, fourteen days after month-end. Reviewing financial data in near real-time allows businesses to detect fraud earlier and make more informed decisions.

4. Document and improve processes.

The ACFE found in their report that nearly half of the fraud cases occurred due to a lack of internal controls or an override of existing controls. Here is how I approach documenting and improving processes:

  • Walkthrough key processes with employees performing them

  • Flow chart the process

  • Ensure step-by-step procedures are documented

  • Cross-train employees using documentation

During the walkthrough and flow chart process, I am looking for areas where an employee needs more oversight of a process. For example, an employee sending invoices, collecting deposits, recording the deposits to open invoices, and reconciling the bank account requires more supervision. This process also allows companies to look for process improvements and cost reductions.

5. Hire an experienced financial professional.

If the above tips seem daunting, a fractional financial professional, such as a2, might be your best solution. Plus, the highest use of most entrepreneurs' time is typically sales, not accounting.

A fractional controller or fractional CFO provides a second set of eyes and frees the entrepreneur to focus on sales or operations. A fractional financial professional can also guide your business to being more profitable and financial clarity.

Trusting your bookkeeper isn’t enough to protect your business from fraud. You need a second set of eyes reviewing the numbers and overseeing your accounting department to ensure accuracy and transparency in your business.

When you add this extra layer of protection, you’ll also recognize additional benefits.



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