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Are You at Risk? Protecting Yourself From Fraud

The second in a series about preventing fraud from affecting your business.

There are many scrupulously honest, dedicated and loyal employees who would never dream of defrauding their employers. But, unfortunately, there are far too many frauds committed against innocent business owners by employees who are “wolves in sheep’s clothing.” The following information will help you become more knowledgeable so that you can begin to protect yourself.

Why Are Small Businesses So Vulnerable?

Lack of financial expertise. Individuals typically start new businesses by converting years of advanced skills and industry expertise into marketable products and services. A small business owner generally has abundant technical skills (to provide a product/service) and people skills (to sell the product or service). But rarely does he or she have the financial expertise to run a business.

Most business owners are happiest when they are producing or selling and would prefer to have someone else handle the financial side of the business. Many owners are uncomfortable working with numbers, or are not interested in investing valuable time to learn how to understand or structure their financial information.

Lack of risk awareness. Business owners are usually hard working, honest, positive and upbeat individuals who project the same attributes on others. Because they are risk-takers with a certain sense of invulnerability, they are not typically suspicious and often fail to create even the most basic financial controls or safeguards for their companies.

To heighten your risk awareness, you should periodically remind yourself that there are others who may:

• Be less honest and straightforward than you
• Feel they deserve a paycheck every week regardless of work delivered
• Think that they deserve to earn far more than you pay them
• Feel entitled to “adjust” their incoming funds to higher levels
• Perceive that, because you are a business owner, you are a wealthy person
• Believe they deserve some of your money
• Believe that if you don’t have strong controls in place, that you are inviting them to help themselves
• Expertly conceal debt, alcohol or drug issues for extended periods of time.
• Initially intend to “borrow” some funds for a short time but then can’t pay it back. As their cash needs continue, they continue to “borrow” from you.

Limited information and resources. Information about fraud risks and controls is not common knowledge or readily available. CPAs, internal auditors and security officers are trained in common risks and controls, but this specialized information is not regularly distributed to the public.

Because small-business fraud is seldom prosecuted and because small businesses don’t have human resources departments to properly investigate applicants, embezzlers are often free to move from business to business.

Business owners often believe that fraud can’t happen at their companies or that the additional work required to implement the controls is too costly or time-consuming, given their current staff. (Too often, they implement fraud controls only after a large fraud has been discovered.)

Additional Construction Industry Stressors

More than most businesses, the construction industry is susceptible to financial control weaknesses. On the financial and accounting side, home builders:

• Experience high-dollar flow-through situations. Even if your bottom line is extremely modest, funds coming in and funds going out are much higher than in other small business environments. These large amounts and numerous transactions can create a high-temptation environment for individuals with access to assets.
  
  
• Many companies undervalue the importance of timely, accurate financial information. However, business owners cannot be confident about the numbers they see in their financial reports when records are messy or non-existent and the financial environment lacks control. They are unable to spot financial problems when they occur.
  
  
• Financial transactions are complex (e.g., job costing, various allocations, percentage of completion and completed contract entries) and can be difficult to follow or understand. This makes it easy to hide or “bury” fraudulent transactions, especially when financial controls are weak or non-existent.

On the operational side, owners are exceptionally busy handling the numerous phases of construction projects. Extra-busy owners have little time to dedicate to the financial side of their business. They also have a tendency to delegate heavily (especially on the financial side), and may also spend a great deal of time in the field away from the office. All of these factors contribute to a loose financial control environment and higher risk of fraud.

Fraud Quiz ― Part 2

Here is the second half of the quiz initiated in this series’ introductory article. Ask yourself the following questions to assess your knowledge of fraud risk areas (answers are at the end):

1.   Employees who commit fraud often do so because (choose all that apply):

1. They need a short-term loan and intend to pay the money back.

2. They observe that small errors or obvious discrepancies are not challenged or corrected.

3. Their lifestyle (or other financial circumstances) requires additional funds.

4. The opportunity consistently presents itself.

5. They have a drug or alcohol problem.

6. They have a criminal background.

7. Additional funds will allow them to take more time away from work.

8. They want to “get even” with the boss.

2.   Small business owners who discover that an employee has committed a relatively small fraudulent act are likely to (choose the best answer):

1. Confront the employee, deliver a stern warning and keep a close watch on the employee until they are sure the person has “learned his or her lesson.”

2. Immediately dismiss the employee.

3. Contact their attorney and accountant for advice on how to proceed.

4. Report the fraudulent act to authorities.

5. Prosecute the employee.

6. Receive full restitution from the employee.

3.   When hiring bookkeepers or internal accountants, most small business owners make their hiring decision after:

      a.   Performing in-depth background and credit checks, discussing the candidate’s skills, work habits and honesty with former employers, and testing the person’s software and accounting skills

      b.   Conducting several interviews, reviewing the candidate’s educational background, formal credentials and resumes, and satisfying themselves that the individual appears to be hard working and honest

      c.   Learning that the individual is the most reasonably-priced applicant available, that he or she seems to be reasonably intelligent, has “bookkeeping experience,” has worked with the existing accounting software and that the person is “willing to work hard and to learn”

Answers:

1.  a.   Most employees who commit fraud truly intend to pay the money back.

      b.   If small errors or obvious discrepancies in the books are undetected by owners or management, it quickly becomes apparent to the bookkeeping staff that no one is paying attention to the financial records. It’s like announcing to the staff that you’re leaving your finances unattended.

      c.   In today’s society it is very easy to live (or aspire to live) well beyond one’s means. And a variety of other financial stresses (e.g., medical costs, divorce, emergencies, family demands, peer pressure) can motivate anyone who is easily tempted.

      d.   When employees are consistently given unmonitored access to assets, only a person of true integrity would not be tempted to “borrow — just a little.”

      e.   Drug and alcohol problems are abundant, and unfortunately, many of the people with those issues are also skilled people-pleasers and masters at hiding their situations. Unless you screen out these individuals during the hiring process, you end up with an employee who is an expert at subterfuge and is also likely suffering from money problems.

      f.   Chances are that only a small proportion of the people who apply to work for you have any kind of criminal background. But if they did, how would you know? How thorough are your background checks?

Answer “g” is unlikely because an effective fraud requires continual close monitoring, so perpetrators may actually take far less time away from work than other employees.

Answer “h” is generally not the primary motivating factor for embezzlement.

2.  a.   Many employers choose this “parental” approach. You should exercise caution with this as keeping an employee who has committed fraud on staff may void your bonding insurance.

      b. through e. Although some business owners choose one or more of these options, they are not the typical responses to discovering internal fraud. Why don’t people report fraud? Some of the reasons may include:

• Shock and denial
• Parental forgiveness of employee
• Feeling sorry for the perpetrator
• The potential for unfavorable publicity
• Personal embarrassment about being fooled or being a victim
• Cost/time related to prosecution
• Easiest route is to just ignore and “go on”

      f.   Although I have seen fraud cases taken to court, court-ordered restitution and fraud perpetrators begin to make restitution, the chance of receiving the lion’s share of embezzled funds is rare.

3.  c.  The answer should be “a,” but the real answer, based on my experience, is “c.”

Diane C.O. Gilson, CPA, CIA, is a Certified QuickBooks ProAdvisor and MasterBuilder ProAdvisor, author, trainer and construction accounting coach, as well as a frequent speaker at The International Builders’ Show and The Remodelers’ Show. Her firm, Info Plus Accounting PC/CPA, offers bookkeeping and support services to help construction companies do more accurate and timely job costing and run better management reports. Contact Gilson via e-mail, or call her at 734-544-7620.

Earlier Articles in this Series

• To read, “Protecting Yourself From Fraud: An Introduction,” Part 1 of this series, published Dec. 15, click here.

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