The Fraud Factor

The kind of people who read Ordinary Brilliance and/or are my clients tend to be very upstanding, high integrity folks. They’re probably not worried about employees or family members committing fraud in their business.

Yet, we all know people can do the most unexpected things under certain circumstances, so it’s important not to get too lax with the controls in your organization.

I know business owners who hand the whole thing over to a bookkeeper, controller or administrator and never check the work or validate the information. Others are so afraid of fraud and embezzlement by employees that they refuse to let anyone else come anywhere near their financial books and systems. Either extreme will be bad for your business.

One of my small business coaching clients, Carl Shaw, a CPA in Hendersonville, NC, was telling me recently about a fraud situation that had recently been brought to his attention. A senior executive of a local business had been entrusted by the owners with all aspects of the organization’s finances. Cash receipts and deposits, ordering and paying for supplies, reconciling bank accounts, all done by this one executive… for more than ten years! When the owners recently discovered that there was not enough money in their bank accounts to cover their payroll (a nice way to say that paychecks were bouncing!) an investigation into the records uncovered that the trusted executive had stolen an amount totaling in the hundreds of thousands of dollars.

In addition to his tax and auditing work, Carl is a Certified Fraud Examiner and helps businesses and organizations set up systems of checks and balances to prevent fraud. He gave me some good info about fraud.

Fraud investigators have found that almost every fraud can be found to contain three common elements, commonly referred to as the Fraud Triangle. These three elements are:

1) Opportunity to steal without being caught, (there’s either not a system designed to prevent a fraud, or there’s an exploitable weakness)

2) Rationalization of why it’s OK in the mind of the perpetrator, (examples – I’m not being paid enough; I deserve more!), and

3) Pressure, external or internal that causes a need for money and gets the fraud started (for example an addiction, credit card debt, or a medical emergency).

The Association of Certified Fraud Examiners (ACFE), the world’s largest anti-fraud organization, does an annual survey to measure the extent of fraud in the workplace. Their 2010 survey showed that the typical organization loses 5% of its annual revenue to fraud. Applied to the estimated 2009 Gross World Product, this figure translates to a potential annual global fraud loss of more than $2.9 trillion!

ACFE reported that the median loss caused by the occupational fraud cases in their study was $160,000. Nearly one-quarter of the frauds involved losses of at least $1 million.

Just who is committing the fraud? The survey indicated the following statistics:

• More than 80% of the frauds in the ACFE study were committed by individuals in one of six departments: accounting, operations, sales, executive/upper management, customer service or purchasing.
• More than 85% of fraudsters had never been previously charged or convicted for a fraud-related offense.
• One of the most common red flags is employees who are living beyond their means (43% of cases) and experiencing financial difficulties (36% of cases).
• The median amount of each fraud is $80,000, much higher if the fraudster is a manager or executive.
• A typical fraud lasts for eighteen months before being detected.

The survey also pointed out that “Small organizations are disproportionately victimized by occupational fraud. These organizations are typically lacking in anti-fraud controls compared to their larger counterparts, which makes them particularly vulnerable to fraud.” Victim organizations that had these controls in place had significantly lower losses and time-to-detection than those organizations without the controls.

The lesson here is to be smart, not fearful. Every business and organization needs checks and balances and a well-thought out system to make fraud and embezzlement very difficult. The honest people will understand and those tempted will find it difficult to pull off.

Although Carl is very busy these days, as a true southern gentleman he offered to talk (no charge) to any of my subscribers who has a question about fraud prevention. (carl.shaw@cshawcpa.com or (828) 698-7725) Don’t let an iron grip on your financial system strangle your growth. With the right system in place you can let others handle most of that work and be free to focus where you’re most needed in your company – marketing and innovation.