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How to Reduce Your Risk of Fraud Loss

I recently receive an email notifying me of a million dollar award from the International Monetary Fund’s West Africa office.  All I have to do is send them my banking information so they can make the deposit to my account.  After a brief daydream on how I was going to retire, I shredded the email, like I have with all of the other notifications of my new found fortune.

This attempt at fraud is obvious to most of us, but the potential for fraud in business is much more subtle. 

In the language of the accounting profession, the method for minimizing the risk of loss from fraud or error is the implementation of a system of “Internal Controls.”  Internal Controls involve the separation of duties among staff and the implementation of procedures that have been found to be effective in minimizing risk.  While adopting a comprehensive system of internal controls is routine for the large business, it becomes problematic for the small business.  Separation of duties may be impossible with a very small staff, and the entrepreneur is often too busy to devote the attention needed monitor this function of the business.

There are procedures, however, that even the smallest business and the busiest entrepreneur should implement. While these procedures will not eliminate the risk of fraud loss, they can reduce the exposure.

Have the bank statements delivered to the owner or responsible board member’s home.  That person should open the bank statement review the activities for reasonableness, and review the cancelled checks.  In reviewing the cancelled checks, one should ask the following questions:

            Does it look like one of our checks?

            Is the check number out of sequence?

            Did I sign this check?

            Do I recognize the payee?

            Is the amount reasonable for this payee?

This initial review will help to identify problems.  It will also put staff on notice that the boss is “looking over my shoulder.”  The bank statement should then be reconciled.  The bank reconciliation should be reviewed by the owner/board member, noting reconciling items and that the balances on the reconciliation agree with the bank statement.

Review monthly financial statements.  This review should include, where applicable, a comparison with budgeted expectations, a comparison with the immediately prior financial statement, a comparison with the prior year, and a comparison with industry norms.  While each of these comparisons may not be available to you, unexpected changes are a clue to problems that could include fraud.  This function is vital to knowing your business, in addition to the internal control benefits.

Review all invoices prepared and sent to customers, noting any missing invoices.  You should periodically review accounts receivable aging for uncollected accounts and bad debt write-offs.  Manipulating accounts receivable is a popular method of fraud.  Reviewing the accounts receivable aging also helps you keep a pulse on your customers.

Review accounts payable aging and vendor payments for unusual or unknown vendors.  Creating a false vendor is one common method of fraud, as is altering the payment payee after the payment is approved.  Reviewing the accounts payable aging will alert you to incurring unneeded finance charges or potential damage to your credit standing.

Institute a records retention policy.  Having adequate records is not only necessary to support tax and regulatory filings, it is also valuable in providing evidence if and when a fraud problem occurs. 

These suggestions will not eliminate the risk of fraud, but they can greatly reduce that risk.  They will also help you to better know and manage your business, thereby increasing your opportunities for success.