Money Management - October 2003

Protect Your Company From Fraud

by Charles Clawson

Do you want to protect your company against fraud? Look first to your employees. Over 64 percent of the perpetrators of fraud are employees of the business. And background checks before you hire employees won’t help. Only 7 percent of perpetrators have ever been previously convicted of a crime.

Be Aware of the Dangers

The first thing a business owner needs to understand is that fraud exists. The two most prevalent types of fraud a company faces are skimming and kick-backs. Skimming involves the theft of cash or inventory from a business. Skimming can be as minor as taking change from the petty cash box or taking a pack of Post-It notes home. Or, skimming can be as material as taking cash from the register, forging checks or taking tools and inventory. Most often, one individual, profiting from the company’s oversight and lack of internal controls, perpetrates skimming.

Kick-backs, on the other hand, usually require a collusion of two or more individuals. One example would be an employee with purchasing authority who requires a vendor to compensate him on the side, so he doesn’t give the company’s business to another vendor. An employee and a vendor may inflate a contract price and split the extra money. Some may consider kick-backs to be "a part of doing business", but they are illegal and harm the company because it pays higher prices for goods and services.

Prevention is Easier than Detection

Fraud is difficult to detect because the perpetrator is intentionally covering his or her tracks. Most company employees are not trained to detect or notice signs of potential problems. A company can retain a CPA to investigate after the fact and uncover the criminal activity. That stops the perpetrator, but how much damage has already been done?

An ounce of prevention is worth a pound of cure. A company, with the assistance of a professional, can establish and implement strong internal controls that make it much more difficult for would-be perpetrators to commit fraudulent acts. For example, the duties of approving invoices and paying them should be separated. If the same person approves invoices and pays them, that employee has the ability to approve false invoices and pay out checks to friends, relatives or bogus companies.

Another example of an internal control that could be established is counting inventory. An owner of a snow cone stand could implement a policy that he is going to count the cups at the beginning of the day and at the end of the day to calculate how many snow cones have been sold. If the cash in the register is less than the expected revenue based upon the cup-count, the owner might suspect employees have been giving free snow cones to their friends. The added benefit of implementing a control policy is that employees are less likely to commit fraud if they understand that the company has ways of determining if fraud is being committed.

To reduce the risk of kick-backs, a company could implement controls that compare pricing between vendors, require financial disclosures from the purchasing employee or rotate personnel assigned to purchasing.

Conclusion

Fraud is a criminal activity that can damage businesses and people. Business owners must be aware of the types of fraud and who perpetrates them. A company’s best weapon against fraud is strong internal controls that discourage fraud before it is conceived and detect fraud once it has been committed. Consultation with experienced professionals, such as CPAs and attorneys, is critical to the successful implementation of internal controls, fraud prevention and recovery.

Charles Clawson
Charles Clawson is a partner with the law firm of Alverson, Taylor, Mortensen, Nelson & Sanders.