Why are small businesses susceptible to fraud? When you are focused on creating a company almost all of your time is spent on sales, operations, manufacturing, innovation and hiring. After all of that there is little time left to think about fraud. Not every company becomes a victim of a fraudster but enough do that it warrants some research.
Every two years the Association of Certified Fraud Examiners conducts a survey to look at fraud internationally. The 2018 “Report to the Nations On Occupational Fraud and Abuse” is available for those interested in the topic but I will summarize the important points.
Fraud on businesses falls into three categories even though many schemes include components from more than one category.
In the United States the most common is Asset Misappropriation which is the theft of cash, inventory, equipment or other assets or causing the company to disburse a payment that is not warranted. About 89% of fraud falls into this category. Asset Misappropriation is most common but fortunately also results in the smallest loss. The ACFE report states that the median loss from Asset Misappropriation was $114,000 and they are underway for 1-2 years before they are discovered. While this was the smallest loss, think about your company. If an employee stole $114,000 could the company (or you) survive financially? If such a loss came to light what changes would you have to make to ensure the company you created survived?
Corruption such as procurement schemes or bribery are involved in 38% of fraud cases. Corruption resulted in a larger median loss of $250,000. Bu the way, the average corruption fraud scheme lasts over 18 months before it is discovered.
Financial Statement Fraud which comprises 10% of fraud schemes involves overstating or understating net income on the company’s statements or tax returns. Financial Statement fraud is the most complicated form. It occurs least often but is the most damaging. The median loss from this fraud type averages $800,000. Few small businesses can come back from a loss of this magnitude. It takes time to steal nearly a million dollars but financial fraud cases have an average duration of over 24 months before they are discovered.
Remember that most fraud schemes are some combination of these three.
So how are these frauds discovered?
In many of these cases a tip (usually from an employee) leads to the discovery of the ongoing fraud. In the United States frauds are reported by employee tips 40% of the time although for small businesses this falls to less than 30%. Another 13% are discovered when managers review documents and report finding discrepancies that lead to the fraud (much like the one I discovered – see “Who and Why”). If your company has an internal audit function they may discover another 15% but no other discovery method approaches an employee tip or a manager review.
It should not be a surprise that an active detection process will help discover a fraud before it goes on too long or steals too much money. In fact management reviews and internal audit have been shown to significantly decrease the duration of a fraud and decrease the amount lost to much less than average regardless of the type of fraud being perpetrated.
What does this mean to you? Fraud can occur in your company and may be significant enough to do lasting damage. In my next post we will discuss more of the varieties of fraud, their impact on you and what you can do about it.