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Managing Financial Fraud Risk in Your Small Business

Business Insights

Financial fraud is an important exposure for companies of all sizes, but the risk is especially acute for smaller organization that often have fewer controls than larger companies.

Even small embezzlements can have acute financial effects on a small business, as well as morale problems resulting from a breach of trust.

Although many small businesses have closer relationships among employees than their larger counterparts, it’s important for owners to remain vigilant and protect their companies against financial fraud risk.

Common Schemes

The most common types of fraud small businesses face are committed by employees, and tend to fall into two broad categories: financial fraud and theft of assets.

As companies consider ways to reduce their financial fraud risk, it’s helpful to understand that most embezzlements are committed by a trusted employee who is conducting a fraud for the first time.

It may start with financial pressure, caused by a divorce, medical expenses or similar family event, and usually includes a rationalization that the worker will repay the fraud once his or her financial situation stabilizes. This, of course, doesn’t take place as the worker realizes paying the money back may indicate it was missing.

Common ways money is removed from a business include skimming sales or petty cash, writing checks to fake vendors, voiding checks in a register and then using them to make personal purchases, adding false employees or relatives to the payrolls, or misusing company credit or debit cards.

Strong Defense

While the first-time nature of most financial fraud makes identifying dishonest workers challenging, it’s important to conduct background and credit checks for prospective employees — especially those applying for finance-related roles. Background checks are not a guarantee, but you can at least reduce the risk of hiring someone who has conducted fraud at a previous employer.

Another important way small business owners can reduce the risk of financial fraud is segregating workers’ duties so no single employee maintains control over an entire finance-related process.

For example, if a bookkeeper opens bills, enters payments into your financial software, prints checks and reconciles your bank statements, there’s almost no oversight of that process, and therefore there’s an increased risk for fraud.

A good way to reduce that exposure is to sign up for automated bill payment, which reduces your need to write manual checks and therefore an employee’s ability to draft a fraudulent check.

Similarly, using a lockbox service from your bank provides an effective control against incoming checks being diverted into an account controlled by a dishonest worker.

A related scam is doctoring bank statements and other financial records to provide misleading information about account balances. A good defense against this risk is switching to paperless statements that you download directly from your bank.

It’s also important to insist that any workers with financial responsibilities take at least a week’s worth of vacation at a time. While it may appear that a bookkeeper who works late and never goes on vacation is really dedicated, they may in fact be trying to prevent anyone else from looking at the books.

With some strong internal procedures and regular review of your company’s financial records, you can help reduce the risk of your small business being victimized by fraud.

The views expressed herein are those of Dave Pelland, as of the date above and are subject to change. This publication is for informational purposes only and should not be construed as a recommendation for any specific insurance product or service. Information has been collected from sources believed to be reliable, but has not been verified for accuracy. These views and opinions do not necessarily represent those of Bryn Mawr Trust, its directors, officers, affiliates, and/or any/all of the contributors to this site. It does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not endorse any third-party companies, products, or services described herein and assume no liability for your use of this information.

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