Top tips to combat internal fraud

By Martyn Solomon.

Instances of fraud are increasingly appearing in the news headlines but we all tend to assume that it won’t happen to us, that we know and can trust our staff and suppliers.

However, studies suggest the typical organisation loses five percent of its annual revenue to fraud. And organisations with fewer than 100 employees are disproportionately victimised by employee fraud, often because they lack the controls of larger businesses.

In addition to the obvious direct financial implications, fraud negatively impacts organisations in many ways. There are the costs of loss of reputation amongst customers and stakeholders and the costs of investigating fraud losses (which statistics have shown come to ten percent of the known fraud value). There’s also the psychological impact fraud can have on its victims, including business owners and work colleagues.

There are three factors common to almost all cases of fraud:

Motive – the perpetrator experiences a need, for example to repay a loan, gambling, drugs, support an extravagant lifestyle, relationship break-up.
Opportunity – the perpetrator believes he or she can get away with the fraud because of poor internal controls and a low chance of detection.
Rationalisation – the perpetrator justifies his or her actions – ‘the ends justify the means’. When motive and opportunity come together the perpetrator looks for some way to justify the actions. Some examples include being overlooked for promotion, everyone does it, the company can afford it, I’ll pay it back etc.

Fraud can be committed by an employee at any level within an organisation, as well as by those outside the organisation. Many organisations have been forced to cease operations because of the impact of financial and reputational damage caused by fraud.

Business owners therefore need to consider fraud risk as a genuine business risk that needs to be managed and monitored like any other business risk.

All businesses are different and should consider the areas where they have less oversight of their business operations. Typical fraud risks include:

Theft of inventory and cash.
Theft of information.
Employees purchasing goods on the organisation’s account for their own use.
False invoicing and payments to fictitious suppliers.
False timesheets and expense claims.
Personal use of equipment.

The three steps to effective management of fraud risks are Prevention, Detection and Response.

Prevention of fraud can be reinforced by having robust procedures in place over areas such as:

Cash and cheque handling.
Access to key computer systems such as payroll and online banking systems and customer and supplier data files.
Purchasing of goods and services and recording of assets and inventories.
Robust upfront vetting of employees and suppliers.
Physical access to sites, assets and inventories.

Procedures to increase the detection of fraud include:

Performing regular reconciliations of key financial accounts and investigating any differences.
Performing data analysis routines to identify unusual and suspicious trends, transactions and data.
Performing analytical reviews of key financial accounts and investigating variances.
Performing random spot checks of cash and inventory holdings.

 Identifying common ‘red flags’ amongst employees such as:

Changes in behaviour and attitude
Affording a lifestyle beyond means
Personal problems
Taking few holidays and working odd / long hours
Stress / low morale / nervousness
Excessive staff turnover
Lack of segregation of duties
Sudden resignation or failure to attend work for no reason.

Business owners can respond to fraud by:

Taking expert advice immediately when investigating apparent or suspected cases of fraud. Methods for obtaining and safeguarding evidence for potential use in a prosecution and for approaching suspected staff are complex and should be undertaken only by those with appropriate knowledge and experience.
Ensuring that identified fraud weaknesses are actioned to prevent them from taking place or recurring. Also, ensuring they have sufficient fidelity guarantee coverage in their business insurance policies.

Martyn Solomon is a senior client manager at Crowe Horwath.