Strategies to Detect and Prevent Business Fraud

We have all come across business fraud at some point. If you own or manage a business, fraud comes with the territory. You’ll see it eventually.

During my 20 years in business finance, I have worked with several companies that dealt with the effects of fraud. In some of these cases, the company faced potential closure. Surprisingly, none of the frauds were particularly sophisticated and most could have been prevented. Here are some types of fraud with suggestions on how to mitigate it.

Clients who don’t intend to pay

While not technically fraud, these situations are just as painful and expensive. In the following scenario, your company signs up a new client, delivers the product, performs the work according to a purchase order and submits an invoice. However, the client delays payment and stops responding to your phone calls. Your invoice eventually becomes what is commonly referred to as “bad debt.” Only later do you discover that this client has a reputation for never paying on time—if at all. Collections agencies are chasing them. Your company is just the latest vendor to do business with them.

Solution:  This common situation can be easily mitigated. Run a commercial credit report on new prospective clients, especially for large contracts. Avoid offering terms to clients whose reports indicate questionable payment histories. Avoid companies with open collection agency accounts, major lawsuits and more.

Employee theft

Employee theft is likely the most damaging and corrosive type of fraud a company can experience. It ranges from employees stealing minor items to major financial fraud, a serious issue. Major employee theft in companies typically occurs because a single employee in a “trust position” abuses their power. We have seen situations where a trusted employee approved fake orders, handled the vendor’s payment and issued payments to their personal account.

Solution:  Employee fraud is nearly impossible to prevent. However, you can limit your exposure by implementing these tactics.

Divide fiduciary tasks. An effective way to minimize internal fraud is to divide fiduciary tasks among employees, such as approving transactions, processing payments and managing bank accounts. No single employee has the power to perpetrate the fraud. Additionally, work with your bank or payment processor to establish a dual-approval solution, which requires two employees to approve disbursements that exceed a certain amount.

Review accounts and financial statements regularly. Reviewing your financial statements regularly provides a clear picture of your company’s financial health. It also familiarizes you with your numbers and helps you catch potential issues. This practice is especially helpful if you run a small company.

Consider fidelity bonds. Getting a fidelity bond on employees with access to your accounts or payment systems covers your company if a bonded employee harms your company due to financial dishonesty. For example, companies usually get a bond to cover employees who oversee the substantial assets of their company’s retirement plans.

Vendors that submit inflated invoices

Companies that buy products in bulk may encounter vendors who charge the full price for the order but fail to deliver the entire order. The discrepancies may be minor, with the hope that your team will not notice. Over time, these minor discrepancies add up.

Solution:  Check vendor invoices against your purchase order and the items delivered before making a payment. Ensure the invoices and purchase orders are accurate and match. Companies that make a large number of purchases but cannot check every order should consider spot-checking. Select a few orders at random and verify those. Expand your verifications if you find discrepancies.

Fake vendors and invoices

We’ve seen an increase in fake vendors submitting fraudulent invoices. This fraud can take many forms. In some cases, the purported vendor submits an invoice for a generic product or service. The invoice amount is small, and the fake vendor hopes that someone will pay it without asking questions. More complex forms of this fraud have the fraudulent vendor impersonating a larger, well-respected company. They create a fake website that copies the authentic vendor’s site, create realistic invoices and even maintain a well-staffed call center masquerading as an “accounts receivable” department. Most fraudsters initially target larger companies. However, many of these scams are now targeting smaller businesses.

Solution:  There is no single way to catch these invoices, and no method is 100% effective, but issuing purchase order numbers for purchases above a specific value can minimize the problem. Require that all vendor invoices include your purchase order number. Cross-check the invoices against the purchase order. Flag any invoices that don’t have a purchase order  number and request that the vendor provide the purchase order  number before you pay the invoice.