Small businesses are particularly susceptible to fraud for a number of reasons:
- The owner-manager is typically very busy, out promoting the business and working to create revenue, yet not comfortable with the reporting requirements internally and therefore not aware of how receivables and payables are being managed.
- The size of the organization restricts the ability to install the necessary internal controls designed to prevent and detect fraud.
- The owner is trusting.
Why do employees commit fraud and how to mitigate the factors:
- Financial pressure – a need to generate additional funds either to support a habit (shopping, gambling or drugs, for example) or support an image (breadwinner). Be aware of red flags that may indicate financial pressure. These indicators can include:
- suddenly purchasing more material items,
- suddenly carrying large amounts of cash,
- frequent calls from creditors,
- irritable or moody behaviour,
- unnecessary overtime,
- arriving for work early and staying late,
- the mention of medical problems,
- signs of drug or gambling addictions, and
- dissatisfaction at work.
- Rationalization – the belief that the company or owner ‘owes’ the employee or that the company has so much, it won’t even notice, or that others do similar things so it’s ok to join in. This can be mitigated by:
- Promoting a strong sense of ethical behaviour within the business. Doing so will reduce the ability of the employee to rationalize the misappropriation.
- This is a simple as a consistent performance management process whereby employees’ work is reviewed and assessed regularly. It can also be a more complex system whereby employees sign a corporate code of ethics annually acknowledging the expectations.
- Keep in mind, however, that no matter how strong the corporate governance is, an employee can still rationalize the theft by tying the act to ‘saving a loved one’ or ‘just borrowing the funds’, thereby avoiding the guilt associated with harm to the corporation.
- Opportunity – the ability (knowledge and or access) to commit the fraud is present due to the experience level of the employee, the lack of internal business experience of the owner / manager, complacent management or weak internal controls. This can be mitigated by:
- Implementing a system of internal controls that help to both prevent fraud from occurring in the first place and detect fraud after it has taken place is a key step to undertake for all small business owners.
- This element is the one the owner has the most control over and yet developing a system of processes, procedures and controls that deter employees from committing fraud is usually overlooked due to a lack of understanding by the owner-manager.
*Removing even one of these factors can significantly thwart or mitigate losses.*