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Small Business Self Defense Michelle L. Salazar, CPA/ABV, CVA, CFE

Sally, a business manager for a technology company, wishes she had never heard of the term “forensic accountant.” Due to the forensic accountant’s thoroughness, Sally is facing several years in prison for embezzling $2 million from investors involved in the company. At least she will look elegant standing in front of the judge: Sally spent the majority of her illegal gains on cars, clothing and jewelry.

Surprisingly, it was not the lavish lifestyle that created suspicion among Sally’s co-workers and the company’s investors. Sally informed her employer and the outside investors that there were no more funds to continue product development. The investors became suspicious, and forensic accountants were called in to investigate.

A forensic accountant is a CPA in the specialty practice area of investigative accounting. Forensic accountants utilize their understanding of businesses and financial reporting systems to apply investigative techniques to seek out fraud, theft and embezzlement, reconstruct financial records, and assist with evidence gathering. Like many small businesses, Sally’s company had very limited controls. She was responsible for signing checks, bank reconciliations, requesting loan draws, overseeing the accounting process, and authorizing wire transfers.

Her scheme was simple. After writing checks from the company to her personal checking accounts, Sally recorded nonsense entries in the accounting records. She created fictitious vendors and prepared phony invoices to the company.

Almost any degree of scrutiny of the transactions could have prevented this scheme. Sally – a fictional character created for the purposes of illustration – created an atmosphere of the loyal, trustworthy employee, while using this façade to place her hand deep into the company’s till. Most schemes start out small, but when the scheme is not detected, it motivates the perpetrator to steal even more. And like the case with this company, some perpetrators steal until their company goes broke.

Small businesses are very often the target of internal theft and fraud. Some preventative measures include:

Adequate employee pre-screening: Small businesses should check new employee references and criminal records.

Segregation of duties: Small businesses rarely have the personnel to properly segregate duties, and it is common for them to have accounting departments with one person in control of everything. It is imperative that owners actively participate in the daily operations of the business.

Prosecute offenders with vigor: We have investigated cases where the perpetrator employee went from one employer to another after leaving repeated trails of deceit and theft. Each time the person became more emboldened because of the lack of retribution. Two common schemes involving cash receipts and cash on hand are:

Skimming: Theft of cash before it is recorded on the company’s books or records. The usual thieves are salespeople and accounting personnel.

Cash larceny: Stealing of cash from an organization after it has been recorded on the company’s books or records. The culprit is usually someone who has access to currency. There are many schemes involving fraudulent disbursements of cash, and the two most common schemes are check tampering and billing schemes.

Check tampering includes any scheme in which a person steals his/her employer’s funds by forging or altering a check on one of the company’s bank accounts, or steals a check the company has legitimately issued to another payee.

Billing schemes include those where a person causes his/her employer to issue a payment by submitting invoices for fictitious goods or services, inflated invoices or personal purchases. Generally when fraud is occurring, there are many indicators present. When the fraudster’s legitimate income doesn’t support the lavish lifestyle portrayed, he/she is living beyond their means.

Sudden changes in behavior or personality also are indicators warranting suspicion. Many times fraudsters conceal records for fear of being exposed. The perpetrator will frequently not respond to inquiries or provide evasive nonsensical responses. In many fraud cases, schemes continue for years because employees were not required to take vacations. Hiding an ongoing theft or fraud scheme requires continual maintenance to evade discovery.

Customers complaining about their billings or accounts receivable balance should not be ignored. And perpetrators of internal theft many times are disgruntled employees who believe the company owes them something.

By the time fraud is discovered, it is usually too late to avoid losses. It is difficult to prevent fraud completely, but with prevention controls in place, should fraud occur, the impact can be limited. The first lines of defense are:

Set the tone at the top: The owner’s attitude dictates an ethical or unethical atmosphere, and his/her tone has a trickle-down effect on employees. If management upholds ethics and integrity, so will the employees.

Promote communication within the company: Business owners are wise to promote open lines of communication with employees. Suspected nefarious activity will often be brought to the attention of those in a position to thwart it.

Education: A large number of occupational frauds are detected by an employee tip. The goal is to make employees aware of how theft and fraud is committed and to emphasize the importance of reporting fraudulent activity when it is suspected.

Implementation of internal controls: Internal controls are the measures an organization adopts to: encourage adherence to policies and procedures, promote operational efficiency and effectiveness, safeguard assets, and ensure the reliability of accounting data. Internal controls include segregating duties.

The internal thief is looking for weakness, a way to violate trust to relieve a business of its assets. Business owners must be constantly vigilant to these schemes and should implement procedures to thwart them at every possible juncture.

Common Frauds
Types of fraud reported in 381 cases involving businesses with less than 100 employees: As Published in the Northern Nevada Business Weekly, Volume 5, No. 30, March 12, 2007
Scheme Cases
Percent of Total*
Check tampering 111 29.1%
Skimming 105 27.6%
Billing 94 24.7%
Expense reimbursements 88 23.1%
Corruption 87 22.8%
Cash larceny 75 19.7%
Payroll 68 17.8%
Non-cash 67 17.6%
Financial statement fraud 46 12.1%
Wire transfers 29 7.6%
Register disbursements 8 1.6%

*The total exceeds 100 percent because several cases involved multiple methods of fraud.
Source: 2006 ACFE Report to the Nation on Occupational Fraud & Abuse Republished in The Writ, Volume 30, No. 6, March 2008 under the title “Small Businesses are the Prime Target for Internal Theft & Fraud”
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