Taking the Necessary Steps to Avoid Fraud

Ways to recognize signs of fraud and how to stop it from occuring.

Big Picture

Years ago while I was in college, one of my accounting professors – one of the country’s foremost experts in white-collar fraud – informed us that he was going to spend the class period talking about fraud and how it might affect us during the course of our careers. We were somewhat surprised when he told us that during the course of our careers we would no doubt be witnesses to fraud and may even find ourselves susceptible to its temptations.

Now, some of you may believe that the topic of fraud doesn’t really apply to you and your organization; you believe there really isn’t anyone in your company that could possibly be capable of fraud. But you are wrong.

Most often, the person convicted of fraud is one of the most trusted people in an organization, and as such, has essentially been given total control over fiscal responsibilities. Another telling statistic: In terms of tenure with the company, more than 30 percent of those who perpetuate fraud have been with the company between five and 10 years. In other words, those who have established trust. Your best defense against fraud, then, is to realize that you and your organization are not immune.

Fraud’s three elements
In my college class, we learned about a concept called The Fraud Triangle. To help us remember what this phrase means, our professor drew an analogy: Just as fire requires three elements to exist – heat, oxygen, and fuel – fraud also requires a combination of three elements to exist: pressure, opportunity, and rationalization.

Pressure, of course, comes in the way of financial pressure, whether it is too many bills, overspending, credit-card payments piling up, expensive medical bills, or a myriad of other things that can cause financial strain in our lives.

Opportunity has to do with the position that an individual has within your business structure and how that position can allow them access to steal from you. This would typically be oriented around the financial organization of your business, but could also involve the management of assets that are easily converted to cash.

Rationalization is self-explanatory. The person committing fraud in your company is somehow convinced that he or she “deserves” the money they are stealing from you – to the point, in fact, that they often don’t believe that they are stealing. Whether they believe they are borrowing it and will eventually pay it back, or that they deserve it for some reason, they have rationalized their way into committing the fraud.

An ounce of prevention
So, if I have convinced you that fraud could potentially exist in your company, how do you prevent it? Let’s address each element of the triangle.

Rationalization may be the most difficult to prevent. This has to do as much with the character of the individual as anything. Perhaps the best way to battle individual rationalization is to establish a position that your business will operate under ethical principles at all times and will expect the same from your employees. Indeed, studies indicate that when confronted about their dishonesty, many employees have justified their actions because they perceive that the company they work for (and have stolen from) has committed dishonest or unethical acts with regards to their customers or vendors or even employees. Ironically, the employees who may be aware of these practices are also often those in positions where they can commit fraud themselves.

So it stands to reason that if an employee knows he works for a company with zero tolerance against dishonesty, he may be less inclined to rationalize dishonest behavior. Another way to deter rationalization is to make sure you prosecute to the fullest extent of the law any individual who commits fraud in your company. It may sound brutal and hard-hearted, but the worst message possible is one of leniency on someone being caught. That just gives the green light to others in your organization to do the same.

Pressure to commit fraud, as I mentioned before, comes from an individual’s personal financial circumstances, which may be very difficult to manage as an employer. But there are some practices that can help. Cultivating an “open-door” policy within your business can often serve as assistance to an employee with financial problems. If an employee feels comfortable discussing with the company’s management personnel some financial struggles they might be having at home, it will at least allow you a chance to help them alleviate some of the “pressure” they are experiencing. Formal policies such as payroll advances or employee loan programs can also provide a struggling employee with options other than eventually committing fraudulent activities.

Controlling the opportunity for fraud is the best way for your business to prevent it, and is accomplished through the separation of duties. This practice becomes much easier the larger your financial or accounting department is. For a smaller business with only one bookkeeper or accountant, it’s challenging, but not impossible. For example, no organization, small or large, should have the same person recording bills, paying the bills, and reconciling the bank statements, and certainly not signing the checks. Even with one accountant, you can implement a policy in which someone else in management is reviewing the check run and signing checks, paying attention to any missing sequences of checks, physically verifying voided checks, and questioning payments to vendors or subcontractors that you don’t recognize.

If you only have one accountant and you don’t have anyone else inclined to reconcile your bank statement, you may want to consider paying outside accountants to do that each month as a control measure. As you add accounting personnel, you have a better opportunity to mitigate the risk of fraud by having different people completing various accounting responsibilities such as dispensing petty cash, receiving payments from customers, and other responsibilities that grant access to cash.

Take the necessary steps now
Regardless of how big or small your company is, make a decision now to establish practices to help prevent fraud. Fraud rarely begins with a bold, dramatic act of stealing a significant amount of money. It begins with someone feeling some financial pressure, rationalizing their behavior, and taking advantage of an opportunity to steal a seemingly insignificant amount of money from your company. From there, the problem inevitably grows with time. Take the necessary steps to avoid fraud in your business and you may very well avoid what could be a very ugly situation. Establishing controls in your business doesn’t represent mistrust in your employees. It represents good, smart business practice.


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