Canada: Small Business Owners Are Not Immune To Fraud

Last Updated: March 10 2015
Article by Derek Lai

Because the media focuses on the fraudulent activity that hits larger-scale companies, it is a common misconception that such activity doesn't occur in small or family-run businesses. The dirty little secret is that small businesses are just as vulnerable as large corporations – and sometimes, even more so.

In fact, small and medium-sized businesses make up 32 percent of occupational fraud cases reported in a 2012 survey by the Association of Certified Fraud Examiners (ACFE). And fraud is not cheap. The ACFE survey also shows that private companies experienced an average loss of $200,000 per incident. This loss is in addition to time and energy spent dealing with the fraud once discovered.

What are the dynamics that put this category of business at high risk? Small and family-run business owners often believe they are immune to fraud, it is human nature to avoid topics like fraud - particularly with people you trust, and small businesses with few accounting staff are particularly exposed.

When small business owners are questioned about their system of fraud-protection controls, a common response is "Our bookkeeper takes care of that...why? Do you think our bookkeeper is stealing?!?" Misplaced trust and lack of controls leaves your business and investment wide-open to fraud.

Let's take a step back and think about your business – you obviously pay close attention to employees whom you recently hired; but, what about your longer-term employees? How much trust do you give them? How much control do they have on your business?

Unfortunately, surveys consistently find that fraud is more likely to be committed by your long-standing and most trusted employees.

Although trusting your employees is not in itself a bad thing – trust should never replace sound business practices. Owners have a vested interest in the business whereas employees may not. Accordingly, your employees, no matter how close they are to you, may not share your same goals. The onus is always on the owner to ensure proper controls are in place.

Now, before we jump into ways in which a small business can deter fraud, we must first learn how to identify it. There is no clear-cut way of identifying fraud – it can come from all facets of your business and can be committed by anyone. If your business is suffering from cash flow issues despite normal sales activity, this may be an indication that funds are not going to where they are supposed to. If you are experiencing a squeeze in your profit margins despite strong market conditions, this may be a good time to pay particular attention to expenses being incurred and recorded in your records. Are there any unusual increases in the book values of asset accounts such as inventory? Do any of your employees appear to be living a lifestyle which far exceeds their income? These are some of many questions you as a business owner should be asking yourself.

Building an adequate foundation to identify and prevent fraud doesn't have to be complicated or expensive. Small businesses should focus on low-cost methods including fraud-awareness training programs. There are many resources available which can help teach your staff to identify and report fraud.

Like in any business, you need to do your homework before hiring new staff. Even though a person may be close to you or come highly recommended, proper background checks should be performed particularly if they will have access to your financial information or business assets.

In the bulk of the cases we've seen, the business owners had complete trust in the person committing fraud. Business owners are often heavily involved in day-to-day business activities leaving them little time for proper oversight and review. If the opportunity for theft exists, there's the possibility for it to occur. As a business owner, allocate time for appropriate oversight and review, especially in situations where one or two people complete all the accounting functions. Make it clear to your employees that you watch for fraud and if something doesn't make sense – question it.

Generally, fraud is committed by people who have access to general ledgers and online/electronic payments. Segregation of duties is a simple yet effective technique to deter fraud or detect fraud when it occurs. Segregation of duties can be as simple having different people approve and review transactions. For example, the person preparing bank reconciliations should be different from the person processing payments, payroll or receipts. You should always be leery of a situation where your internal accountant has full control of your bank account and accounting records. Not only can they transfer money to anyone including themselves, but they have the means to conceal it.

Segregation of duties may not be a solution for everyone. For example, small businesses may only have one staff member in charge of finances. In those situations, owners need to play a more active role in the business' financial operations. They need to let their staff know that they are watching over their money. This can include reviewing support when signing cheques, approving purchases before payment and reviewing monthly bank statements/reconciliations for unusual items.

Controls should be tailored in accordance with your business and it is important to understand and balance the cost-benefits of same. For example, a manufacturing plant with many employees will have different controls in place than a start-up company with few employees.

Every business is unique and there is no 'template' which can be used across all businesses but active vigilance will reduce the risk of getting caught off-guard and will help to detect fraud if it has occurred. If your systems and internal controls are worrying you, we can help. Contact your Crowe MacKay LLP representative for assistance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Derek Lai
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