If you don’t have good internal controls, your business could lose a lot. According to the Association of Certified Fraud Examiners (ACFE) 2018 Report to Nations, internal control weaknesses were responsible for 42% of fraud in small businesses (fewer than 100 employees), and these businesses suffered a median loss of $200,000 per fraud scheme — nearly twice as much as larger businesses. Also, once the money is gone, it usually doesn’t come back: only 15% of fraud victims recovered all losses, and most (53%) recovered nothing.
Why does this happen? Small businesses typically have fewer anti-fraud controls than larger ones, leaving them more vulnerable to fraud. Plus, there’s an amazing variety of fraud schemes. So having a few controls in place, such as security cameras and tightly controlled passwords, doesn’t mean your business is fraud-proof.
Types of Fraud
For most small businesses, fraud falls into two main categories: asset misappropriation and financial statement fraud. Of the two, asset misappropriation is the most common, accounting for 89% of the fraud cases in the ACFE 2018 report, with a median loss of $114,000 per fraud. This type includes:
- Theft of cash or inventory through skimming, write-offs, refunds, false sales and other schemes
- Fraudulent disbursements, such as check forgery, false expense statements, ghost employees, padded timesheet hours, and fictitious expenses
By comparison, financial statement fraud occurs much less often, accounting for only 10% of the cases in the study. But it is much more costly, with a median loss of $800,000 per fraud. This type includes:
- Overstatement of income through fictitious revenues, concealed liabilities, improper asset valuations or other schemes
- Understatement of income through timing differences, understated revenues, improper valuations or other schemes
Depending on the nature of your business, you could be more vulnerable to certain fraud schemes than others. For example, a restaurant may be more prone to skimming or tip boosting, while a manufacturing company may be more likely to suffer inventory theft, payroll fraud or fictitious sales. So it’s especially important to protect your business against the types of fraud it’s most susceptible to.
Fraud Controls Work
According to the ACFE report, while every fraud control method the study examined reduced losses, some were especially effective. Having a code of conduct cut losses the most, followed by proactively monitoring and analyzing data. Conducting surprise audits, having an external audit of internal controls over financial reporting, and performing management reviews were also effective. Each of these controls helped the businesses that had them lose 50% less to fraud than those that did not.
Of course, none of these methods work if you don’t have them in place. But even if you do, they alone are not sufficient to protect your business. You should also have controls like these:
- Segregation of duties so that no one person has authority to initiate, approve, complete and record a transaction, such as writing a check or using a company credit card
- Technology access and usage controls, including remote usage and password protection policies, to protect computerized accounting, data management, and transactions
- Written policies and procedures for handling sales and accounts receivable, purchases and accounts payable, payroll, cash management, and financial documentation and reporting
- Regular management review of accounting system reports, inventory counts, bank statements and other reconciliations
- Physical controls, such as safes, security cameras, and controlled access to secured storage rooms and warehouses
Again, depending on the nature and size of your business, you might need different or additional anti-fraud measures; for example, a tip hotline to combat employee theft or anti-fraud software to deter and detect financial misconduct.
Make Sure You Have Them
The ACFE study found that the presence of anti-fraud controls was correlated with both lower fraud losses and quicker detection. Where controls were present, fraud losses were as much as 54% lower, and frauds were detected up to 50% more quickly. Therefore, it’s important to have good internal controls in place to protect your business against fraud.
Please contact us if you have any questions about internal controls and how they can help minimize fraud losses. Our business advisory department will be glad to be of assistance with this and other aspects of running a successful and profitable business.