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It’s an unfortunate truth that most business owners experience some sort of fraud.

When you began your business, you likely didn’t give much thought to fraud.

Retail operators have long struggled with the issues of “shrink” which accounts for about 2% of all sales.

And while shrink is a very real problem, fraud can occur in many other ways in a business. According to the FBI, non-healthcare related fraud is estimated to amount to over $40 billion dollars annually.

The reality is, fraud affects businesses of every shape and size, in every industry.

POTENTIAL OF FRAUD

The National Association of State Auditors, Comptrollers, and Treasurers (NASACT) has developed a “10-80-10” rule.

  • 10% of the population will never commit fraud, no matter the pressure or opportunity.
  • 80% of the population might commit fraud, given the right combination of pressure and opportunity.
  • 10% of the population are actively involved in committing – or trying to commit – fraud.

If these numbers are even close to accurate, then every business owner should be extremely concerned about, and on the lookout for, fraud.

Which brings me to the concept of the “fraud triangle”, a term coined by criminologist Donald Cressey.

AN ENVIRONMENT FOR FRAUD

In order to fight fraud, a business owner has to understand why fraud occurs.

The Fraud Triangle explains that a business is ripe for fraud when three things exist:

  • Pressure – an external force or motive that is pushing an employee toward fraud
  • Opportunity – an ability to perpetrate the fraud with the likelihood of success
  • Rationalization – a justification of the action

PRESSURE

You’ve likely heard someone say – “He was such a great guy. I just can’t believe he did that!”

People often act out of character because of pressure. That pressure can be real or imagined; emotional or financial. It may be invisible to everyone else, but pressure is almost always present for an individual to commit fraud.

Debt, substance addiction, medical issues, workplace stress, family needs, and relationship problems are all examples of external pressures. All of these can push an ordinarily honest person to consider committing fraud. Regardless of the type of pressure, the individual feels that the problem is unsolvable by other (legal) means. Often, this feeling is coupled with individual’s belief that he or she cannot share the cause of the pressure with others, for whatever reason.

OPPORTUNITY

Often, the opportunity trigger is a temporary one – for example, someone in oversight is away from operations unexpectedly. Or perhaps the employee is covering for a team member who is on vacation. In these situations, an employee is suddenly in a position to commit fraud – and that short of window of time can be a powerful trigger. The opportunity trigger is supported by the employee’s certainty that they will not be caught.

Opportunity can also be synonymous with “access”. When an employee has access to the tools, or even direct access to cash or physical goods of value, the temptation to steal or embezzle can be high.

RATIONALIZATION

Few people would be able to commit fraud without rationalizing the action to themselves. Whether they think they are owed something by the company, the company can “afford” to absorb the fraud, or they are intentionally trying to harm the company, there must be a justification in the mind of the employee to move from honest behavior to fraud. Rationalization can happen in the mind of an employee without anyone else knowing, so it is one of the hardest parts of the triangle to identify.

Most employees who commit fraud are not career criminals – they are first-time criminals who see themselves not as criminals, but as victims of circumstance. One common fraud begins when an employee rationalizes to himself that he is only “borrowing” from the company temporarily and will pay the money back.

FRAUD PREVENTION

Although there is no way to eradicate all risk of fraud, steps can be taken to mitigate the risk of fraud. Since rationalization and pressure are very difficult to identify as they can be hidden in the employee-driven, companies can invest in ways to reduce the opportunity for employees to commit fraud.

Opportunity can be monitored and controlled in many ways. Some examples include:

  • Establishing internal controls
  • Segregating key duties that don’t allow any one person total control in a process
  • Keeping assets (i.e. cash, inventory, intellectual property) safe through locks, passwords, and other controls
  • Ensuring management is engaged in operations
  • Setting up review procedures

Companies may want to consider other steps to help mitigate risk, such as:

  • Establishing and communicating company values to employees
  • Setting a “tone-at the top” which establishes management’s commitment to an ethical climate
  • Performing background checks on new employees
  • Having a code of conduct for the company
  • Paying employees a fair and market rate
  • Involving HR in identifying potential pressure triggers

IDENTIFYING FRAUD

Although some fraud will never be uncovered, the following procedures can potentially uncover fraudulent activity:

  • Performing regular and detailed financial reviews (someone other than the person preparing the financials should be reviewing the financials for completeness and accuracy)
  • Reviewing a detailed bank statement and viewing the check images provided by the bank
  • Creating a budget for the company and tracking budget to actual reports
  • Counting inventory regularly
  • Performing spot counts of inventory
  • Performing fixed asset counts

You may be wondering “What about audits? Aren’t they supposed to catch fraud?” Well, the truth is that external audits CAN be a deterrent to someone contemplating a fraudulent act, audits are not designed to identify fraud. Most fraud cases are not caught even when audits are in place. If an audit is your only fraud prevention tactic, then you are opening your business up to significant risk.

Take some time to assess your business’ risk of fraud today. Do your employees have too much access? Are you setting a positive “tone at the top”? Do you do regular and detailed financial reviews? If you want help assessing your current risk of fraud, we’d love to talk to you. Book a call with our team today.

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