By Tiffany D. Helkenn, CPA/CFF
Thomas, Head & Greisen PC

Fraud, an ugly word that business owners don’t like to think about, much less consider that it could happen to them. Though the headlines might not be frequent when it comes to fraud a ecting small businesses, occupational fraud is much more common than business owners may think. According to the Association of Certified Fraud Examiners (ACFE) only 57% of fraud was referred to law enforcement and only 27% resulted in civil litigation. Unfortunately, this means most fraudsters su er few consequences when they are caught, leaving them free to join another organization where the cycle continues.

Fraud that goes undetected for a long period of time can be substantially more costly than fraud detected early. For organizations to identify and mitigate the risks of fraud, it is important to understand three key components of fraud. These are commonly referred to as “The Fraud Triangle” which consists of: incentive, opportunity, and rationalization.

Incentive refers to an individual’s motivation to commit fraud. Financial pressure is a common motive which may be from debt, addictive habits, or simply a desire to live beyond ones means. Pressure to meet targets can also be an incentive.

Opportunity is an individual’s ability to perpetrate fraud in an organization. Opportunity commonly occurs where there is a lack of internal controls. When fraud is perpetrated at a higher level within the company, it is usually due to an override of those controls. More than half of occupational fraud occurs due to either a lack of controls or an override of those controls. Small businesses are particularly vulnerable as they frequently have few sta members which makes a proper segregation of duties di icult. In these instances, it is important for management to be diligent in their oversight.

Rationalization is an individual’s ability to justify their actions. They do this by saying things like “I’m just borrowing money, I’ll pay it back,” or “The company has enough money, they won’t miss it,” or “They don’t pay me enough, I’m just giving myself fair compensation.” Whatever their reason, by the time the fraudster hits this side of the triangle, they have sometimes convinced themselves they are doing nothing wrong.

There are several ways an organization can limit the chances of fraud occurring. Management setting an example of ethical behavior, reducing pressures, and/or providing thorough oversight can lead to a work environment that deters fraud.

An effective way for an organization to mitigate the risk of fraud is to implement appropriate internal controls. Some common controls to consider are:

• Do background checks before hiring.
• Have a code of ethics which employees are required to review that includes honesty.
• One employee should not be able to do all these tasks: keep the books, collect funds, approve payments, write checks, and reconcile the bank statement.
• Restrict access to bank accounts, including limiting signers, who has online access and ensure blank paper checks are secure.
• Conduct or review bank statement reconciliations. Look for unusual items and items that remain on the reconciliation for lengthy periods. Compare the reconciliation to the actual bank statement.
• Adequately secure inventory and supplies.
• Review backup documentation before approving or signing checks. Apply this same process before submitting electronic or credit card payments.
• Have a way for employees and customers to report suspicions anonymously. This is the most common way fraud is discovered.
• Perform periodic inventory observations and asset verifications.
• Watch for behavioral warning signs from employees such as living beyond their means, unusually close association with a particular vendor or customer, and unwillingness to share duties.
• Understand and verify the financial information reported to you. This can be as simple as understanding and reviewing the key indicators for your business.
• Do not rely on “trust”. “Trust” is not an internal control. By “trusting”, you are not protecting the employee or the business. Instead, “trust” gives employees the opportunity to commit fraud.

While eliminating the threat of fraud is not possible, there are steps every business can take to prevent, detect, and mitigate fraud. I recommend reviewing the 2024 Report to the Nations (copyright 2024 by the Association of Certified Fraud Examiners, Inc.) https://legacy.acfe.com/report-to-the-nations/2024/. This report compiles detailed information from nearly 2,000 occupational fraud cases and the critical areas it covers may help you design controls to protect your business. You cannot remove fraudsters from the world, but you can take steps to protect yourself, your employees, and your business.