How to Prevent and Detect Fraud in Small Business

Small businesses suffer from fraud disproportionately because they lack the resources, and sometimes skilled-workers, to help prevent and detect fraud. The level of trust is greater in small businesses and fraudsters can take advantage of their position or that trust by doing things they would never do with their own money.

Fraud prevention is one of the biggest challenges facing small business. Due to the lack of resources necessary to effectively protect themselves, small businesses lose nearly $630 billion to fraud each year and are almost twice as likely to experience internal fraud as larger organizations.

According to the 2012 Global Fraud Survey of the Association of Certified Fraud Examiners (ACFE), occupational fraud is a significant threat to small businesses. The smallest organizations in the study suffered the largest median losses. These organizations typically employ fewer anti-fraud controls than their larger counterparts, which increases their vulnerability to fraud.

Overall, research by the ACFE found that employees were more likely than their bosses to commit a fraud within a company. Of those that had committed fraud at work, 42 percent were employees and 38 percent were managers. Additionally, 18 percent of fraudsters were business owners and executives. 

In the ACFE study, businesses with fewer than 100 employees often lacked formal controls and were shown to be three times more likely than their larger counterparts to discover instances of fraud by accident. Smaller businesses were almost twice as likely to discover fraud when notified by police and were not nearly as likely to uncover fraud through an internal audit.

Compared with large publicly held companies, there are no standards like the Sarbanes-Oxley Act that govern internal controls and certify financial accuracy for small businesses. At the same time, small business owners do not have the budget or resources to develop and implement their own auditing and fraud prevention systems. Furthermore, despite the need for protection, there are very limited tools available to small businesses to counter fraudulent activities.

There are steps a small business can take to protect itself from fraud including:

• Offer internal and external audits.
• Create management reviews and independent audit committees.
• Offer fraud training for management and employees.
• Have mandatory vacation and job rotation.
• Create a hotline/tip line and rewards for whistleblowers. 

To identify fraud, small business should:

• Conduct background checks on new employees that go back over the past seven years on all employees before hiring to see if there is a criminal history.
• With a signed release, check new employees' credit reports for any fiscal irresponsibility. 
• Once the employee is being considered for hire, review their social networks for any items damaging to reputation, especially any past animosity against their former employer.
• Institute an employee policy that outlines expected employee behavior anytime they are representing the company, including any mention on their social networks.

Fraud risks have increased significantly in the past dozen years with the available technology to help commit fraud. We are seeing much more fraud related to computers and people circumventing software to hide disbursements to themselves. Employees with smartphones are essentially running around with minicomputers in their hands and logging in to networks that are not legitimate. Moreover, passwords then get stolen, and accounts and information get compromised. One item of advice is for users not to log in to networks they don’t recognize, and not to open emails unless they are sure they know who sent them.

Increased fraud risk mirrors the general decline in ethics in society. Most people do not think of what is the right thing to do before they take an action, especially in the workplace. Instead, the thought may be how can I better my position or somehow gain by engaging in one activity or another without any thought about how my actions might affect others.

Ultimately, it is up to the small business owner and management to make it clear through word and deed that fraud is unacceptable behavior and will be met with a quick response including demotion, reduction in pay and, when necessary, firing the offending employee.