A client came to me with a problem that is a good cautionary tale for all business owners out there. She was the owner of a small business with 10-15 employees (the exact number varied over the years). The business’ office manager was an old friend and had worked for the owner for almost a decade. The office manager did almost all of the back office paperwork – he invoiced clients, paid suppliers, ran payroll and handled the bank paperwork. He took a day off to take his child to visit college. That day, the owner took a call from a supplier (since the manager was away) and the supplier said that the business had sent them a check for the prior month’s invoice intended for another supplier. The owner apologized and promised to reissue a check that day. She called the supplier who was supposed to get the wrongly mailed check and, sure enough, that supplier also got the wrong check – the two envelopes somehow had been switched. Wanting to be thorough (and to maintain good relationships with her suppliers), she began to call other suppliers on that month’s check run to make sure they got the right payment.
All the other checks were fine, except she found a vendor whose name she did not recognize. She went to the manager’s office and found the vendor’s file. The phone number on the invoice was inoperative and no address was listed. The vendor had no website or e-mail and the owner could not find any mention of it on the internet. For almost four years, the business had been sending this vendor $850 every month for “technical support” services. By this point, the pit in her stomach told her what had happened and she went back through copies of old bank checks to confirm it. The manager had created a dummy company and was sending fake invoices to the business every month. The manager created an alias in the company’s accounting software so that he could issue checks to himself and the software would report that the check was issued to the fictional vendor (the manager knew that neither the owner nor the owner’s accountant reviewed copies of the actual checks; all reviews and audits were done off the accounting software printouts). All told, the manager took the company for a hair less than $40,000. The manager had blown most of the money on vacations and expensive restaurants – meaning there was a very slim chance that the business would be able to gets its money back.
Sadly, this is not an isolated incident. The Association of Certified Fraud Examiners estimates that fraud impacts small businesses harder than larger enterprises – the average fraud loss is higher and fraud rates are more common. And, in light of current economic conditions, more than 50% of small businesses are reporting an increase in fraud over the last 12 months, with half of that number claiming increased financial pressures as the cause of the fraud (thanks to Small Business Trends for these numbers)
This kind of internal fraud usually is a result of the small business’ lack of internal controls. Both the ACFE and the National Federation of Independent Business offer some guidance on how to keep your business clear of fraud:
1. Hiring and Retention: It’s nice that you can give a job to an old friend, but that doesn’t mean you should. And, under no circumstances, should you refrain from employee oversight. It is your business, it is your money and it is your job to make sure that your employees are doing what they’re supposed to be doing.
2. Divide Responsibilities: Unless it’s you, no one individual should have access to all of your financial transactions. Split the responsibilities for incoming and outgoing money, at the very least.
3. Audit, Audit, Audit: Sure, someone does your taxes every year. But, you should audit your books more frequently. Some accountants recommend quarterly audits, others recommend multiple audits each year at random intervals. Make someone besides the person who writes the checks look at the checks and reconcile them to the bank statements and accounts.
4. Treat Your Employees Well: It is statistically less likely for people to commit fraud when they believe they are being treated fairly. This includes salary, benefits, and workplace environment. Are employees encouraged to speak their minds? Is there a way to report misbehavior by other employees (even if reported anonymously)? How do you act? Do you act ethically and honestly with your employees? If you do right by your business and your people, it is much more likely they will do right by you.
This is a great example of a common problem. Small business owners are especially at risk because they might not have sophisticated accounting and auditing practices.
[…] 1, 2010 by ulluccilaw Back in January, we wrote a piece called “Detecting and Preventing Fraud.” In it, we warned of the special vulnerabilities of small businesses to fraud (especially employee […]