Business Fraud and Strategies for Preventing It

Illumeo Customer Success's Profile

Business fraud, also known as corporate fraud, refers to the unlawful activities undertaken by an individual or company, performed in a dishonest and unethical manner. Business fraud is designed for the advantage of an individual or company performing it. Business fraud has an impact on the business, other employees, and outside parties.

Considered a white-collar crime, business fraud can be challenging to prevent and catch. Effective policies, checks and balances, and physical security may limit the extent to which fraud can occur. To disguise the illicit activity, business fraud is often hidden behind legitimate business practices. Multiple stakeholders may also be a part of a fraud scheme protected by a group of complicit actors.

For example, to hide the net loss, slow revenue, declining sales, heavy expenses, a company’s financial accounting records may be cooked to present the image of profits and high revenue generation compared with the actual financial outcomes. This may be done to attract buyers and investors or to protect a company’s stock or valuation from dropping.

All corporate fraud falls into one of three categories: asset misappropriation, financial statement fraud, and corruption.

Asset Misappropriation

As asset misappropriation scheme occurs when an employee of an organization steals or misuses the organization’s assets, e.g., theft of company cash, false billing schemes, or inflated expense reports. A popular type of asset misappropriation scheme is a cash scheme, which includes fraudulent disbursements. A billing scheme is a common type of fraudulent disbursement and occurs when the perpetrator makes a false claim to the organization for payment. An asset misappropriation scheme also includes stealing non-cash assets.

Corruption

In corruption schemes employees use their influence in a business transaction for their personal benefits, violating their duty to the employer. Bribery, extortion, and conflict of interest are the most common corruption schemes. In the 2018 Report to the Nations, ACFE stated that 38 percent of cases studied involved some form of corrupt act.

Financial Statement Fraud

Financial statement fraud is the intentional misrepresentation of the financial condition of a company, accomplished through the willful misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users. It usually involves overstating assets, revenues, and profits and understating liabilities, expenses and losses. However, the overall objective of the manipulation may sometimes require the opposite action, e.g., concealing higher-than-expected revenues or profits in a good year to help the subsequent year that is expected to be tougher.

Here are some strategies that can help you prevent and detect fraud.

Get to know your staff

Every business strives to hire honest employees. Following a formal hiring routine, including background checks should be performed for all staff handling important documents, cash or managing payments, even at a small business, can help prevent fraud.

Close supervision of staff and involving them in the discussion may help an owner of a business to notice the changes in employee’s attitude and pay more attention to a certain worker because it not only prevents fraud but it also helps to create a happier workplace for the team.

Employees committing fraud often go out of the way to help others and gain trust, work longer hours, and rarely take time off. By doing this, they start handling several tasks, with less oversight. Similarly, employees with financial situations in their personal lives or those angry with their managers are more likely to commit fraud to revenge.

Small business owners are surprised to find out the people they least expect to commit the crime. So, it’s crucial to know their staff and regularly engage them in discussions.

Set up a fraud risk policy and maintain internal control

Setting up a fraud policy to inform employees about the types of theft and their consequences is crucial. All employees should be aware of the consequences they have to bear if they commit fraud. Honest employees are an asset because they can help in raising alarm in case of an abnormal activity performed by their coworkers. An anonymous system for reporting fraud eases reporting cases by keeping employee’s identity safe. This helps in detecting and preventing fraud.

Creating and maintaining internal controls can detect and prevent fraud. Restricting access to financial account data, establishing multi-person sign-off, accounting, and payroll functions, and performing an overview of audit logs to ensure the integrity of the books.

Segregate Accounting Duties

Many small companies have a single person for handling bookkeeping, managing and recording client receivables, paying invoices, processing payments, and other functions in accounting software. Because the same person does everything, it’s easy for the business owner to miss fraud.

Businesses should have at least two persons handling these functions interchangeably, keeping the accounting functions separate, or hire a third party or a virtual CFP to handle accounting functions.

Live the Corporate Culture

Creating a positive work environment prevents fraud and theft. A clear organizational structure, well-written policies and procedures, and fair employment practices creates a culture of trust and happy work conditions for all employees. An open-door policy can also provide a great fraud prevention system as it gives employees open lines of communication with management.

The management of the business should lead by example and hold everyone accountable for their actions, no matter what their position is. It’s extremely important to prevent fraud as it can have a great financial impact on business, legal problems, and a ruined reputation.

Many accountants specialize in a subfield of the accounting profession, such as fraud, to become lifelong learners and stay up to date with the latest laws and regulations that govern their field. Fraud costs billions of dollars for companies each year. To prevent and uncover fraud, companies seek the services of industry experts known as certified fraud examiners (CFEs).

The CFEs possess expert accounting skills and in-depth knowledge of how fraudsters attempt to defraud companies. Many companies seek CFEs and professionals with business fraud certification who have in-depth knowledge of each leg of the fraud tree, causes, mitigation techniques, and fraud evaluation methods and fraud red flags, to prevent and uncover fraud.

Frauds still occur with the strong anti-fraud processes in place. For this reason, it’s important to develop a thorough fraud response plan before falling prey to it. The plan should clearly outline what to do in case of discovering a fraud, reporting it to law enforcement, informing creditors, retaining files, and conducting a fraud investigation are important steps to stop fraud and prevent others from becoming victims.