The Dreaded F Word

August 15, 2019

I have participated in countless fraud discussions with financial executives during my time in public accounting. It was surprising and somewhat alarming to learn, when asked about the potential for fraud occurring within their business, many members of management had not seriously considered the possibility of fraud within their organization. Unfortunately, many small business owners have a similar mentality regarding fraud. According to a CNBC/SurveyMonkey Small Business Survey of 2,030 self-identified small-business owners, only 1 percent identified the threat of crime or vandalism as the most critical issue facing their business.

In the 2018 Global Study on Occupational Fraud and Abuse produced by the Association of Certified Fraud Examiners (ACFE), small businesses, defined as businesses with less than 100 employees, lost almost twice as much per scheme to fraud with $200,000 in median losses compared to losses of $104,000 per fraud case in larger companies with over 100 employees. Further, an astounding 89% of the 2,690 fraud cases studied were due to misappropriation of assets compared to 10% due to fraudulent financial reporting. A single fraud scheme could cause significant devastation to a small business. How can a small business combat this silent threat from within their organization?

The fraud triangle identifies three areas that must be present for fraud to be successfully carried out:

Opportunity – For fraud to be carried out, there has to be an opportunity for the perpetrator to commit the act without getting caught. This can be done by exploiting weaknesses in internal controls. Smaller businesses often do not have robust internal controls due to lack of resources and staffing requirements which can allow employee access to assets and ability to cover up fraudulent activities.

Pressure - Reducing the pressure to commit fraud can be difficult for employers given the little control they have over their employees’ personal lives. However, companies can reduce the pressure to an extent by maintaining an open door policy with their employees and recognizing red flag behavior (i.e. refusing to take sick or vacation leave, arriving early and leaving late, living beyond means, etc.)

Rationalization – Rationalization can also be difficult for businesses to control. Setting a positive tone at the top, maintaining updated employee handbooks emphasizing clear expectations and consequences for unethical behavior, and continual ethics trainings are some ways to help employees understand the severity of committing fraud and in turn making it more difficult to justify fraudulent behaviors.

Out of the three components that make up the fraud triangle, opportunity is a key element under management’s control. The opportunity for fraud can be greatly reduced by investing in reviewing, identifying and addressing potential weaknesses in your company’s internal controls. Are you doing enough to prevent and deter fraud in your organization? It would be wise to reevaluate your internal controls before it is too late!

About the Author

Daniel Paulsen is a consultant with Morrison, which provides business planning (including budgeting, cash flow forecasting, and strategic planning), feasibility studies, interim executive CFO services, competitive grant writing, recruitment, and special projects that don't fit into any conventional category. You can contact Daniel directly at dpaulsen@morrisonco.net or via telephone at 530-893-4764 ext. 210.

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