5 ways to spot small business fraud

Fraud can hurt small businesses in a big way. The estimated median losses for small organizations that fell victim to fraud were $150,000 in 2016, according to the Association of Certified Fraud Examiners (ACFE). Small companies are also more likely to be victims of business fraud than any other size organization. While business fraud can be felt in the bottom line of companies of all sizes, the sheer size of these losses can have an outsized impact on smaller firms.

While businesses can - and do - fall victim to fraud of all kinds, employee fraud involving check tampering, skimming, payroll and cash larceny were twice as common in small organizations than in large ones, according to ACFE. 

Small business owners can spot and stop fraudulent activity before losses escalate. Here are five strategies that can help you spot small business fraud:

1. Watch for red flags

Most business fraud is an inside job, and the vast majority of fraudulent employees are first-time offenders. While most employees never engage in this type of activity, small business owners who know their workers well may find it easier to spot changes in behavior that warrant closer attention.  In nearly 80% of cases of employee fraud reported to ACFE in 2016, clear warning signs were present. Watch for:

• Conspicuous consumption and/or living beyond their means
• Financial difficulties
• Recent divorce or other family issues
• Excessive control issues
• A "wheeling and dealing" attitude

2. Consider the business "fraud triangle"

Three interrelated factors can lead an employee to commit business fraud: the financial difficulties described above, a perceived opportunity and rationalization. The third point of the fraud triangle is the most insidious of all. Employees may initially tell themselves they are underpaid or merely "borrowing" small amounts of money they will repay in due time, only to become emboldened once their actions go unnoticed.

3. Implement anti-fraud controls

A broad range of controls can help spot small business fraud, including:

• Internal and external audits
• Employee codes of conduct
• Management review and certification of financial statements
• Employee support programs
• Business fraud hotlines and/or reward programs for tipsters
• Business fraud training
• Countersignature controls
• Formal fraud risk assessments

While some of these strategies are more complex and costly to implement than others, ACFE researchers found small companies use these kinds of controls less often than larger ones. "This gap in fraud prevention and detection coverage leaves small organizations extremely susceptible to frauds that can cause significant damage to their limited resources," the organization said in its 2016 report. Investing in small business fraud control does pay off: Companies with these kinds of safeguards in place reported losses up to 54% smaller than those without them. Safeguards resulted in fraud being detected 33% to 50% more quickly than in companies without them, the report said.

4. Keep a close eye on the bottom line

While most business fraud cases are brought to light by tips, managers in small firms are more likely to detect fraud through reviews, account reconciliations and document examinations that surface employee misconduct, such as skimming and other financial irregularities, than their counterparts in larger organizations, according to the ACFE report. 

5. Don’t let your culture create blind spots

The high levels of trust and close personal relationships found in many small businesses foster loyalty, but they also can provide opportunities for fraud. That’s why it often can be hard to believe evidence of potential employee fraud when it’s brought to light. Implementing consistent controls and policies are a couple of ways of protecting against fraud without damaging the trust at the center of your company’s culture.

Small business owners shouldn’t assume the worst about becoming a victim of fraud, but they can consider these strategies as one way to manage risk. If you’re concerned that your business is at risk of fraud, you can get insurance to protect you from potential damages. Learn how commercial crime insurance can keep your small business covered in the case of employee fraud.