According to the Association of Certified Fraud Examiners (ACFE), over $3.5 trillion is projected to be lost to fraud worldwide in 2011 alone. The typical organization loses 5 percent of its revenues each year. While we have a lot to think about as entrepreneurs, we do need to take time to educate ourselves about this unfortunately common business loss.
The Fraud Triangle
An easy way to understand fraud is to learn about the Fraud Triangle. The creation of the Fraud Triangle is credited to Dr. Donald Cressey, a well-respected criminologist and sociologist who made significant contributions to his field.
Three components need to be present in order for fraud to occur:
Motivation (or Need)
Rationalization
Opportunity
When fewer than three legs of the triangle are present, we can deter fraud. When all three are present, fraud could occur.
Motivation
Financial pressure at home is an example of when motivation to commit fraud is present. The fraud perpetrator finds themselves in need of large amounts of cash due to any number of reasons: poor investments, gambling, a flamboyant lifestyle, family requirements, or social pressure. In short, the person needs money and lots of it fast.
Rationalization
The person who commits fraud rationalizes the act in their minds:
I’m too smart to get caught.
I’ll put it back when my luck changes.
The big company won’t miss it.
I don’t like the person I’m stealing from.
I’m entitled to it.
At some point in the process, the person who commits fraud loses their sense of right and wrong and their fear of any consequences.
Opportunity
Here’s where you as a business owner come in. If there’s a leak in your control processes, then you have created an opportunity for fraud to occur. People who handle cash, signatory authority on a bank account, or financial records with poor oversight could notice that there is an opportunity for fraud to occur with the ability to cover the act up for some time.
Prevention
Once you understand a little about fraud, prevention is the next step. To some degree, all three points on the triangle can be controlled; however, most fraud prevention programs focus on the third area the most: Opportunity. When you can shut down the opportunity for fraud, then you’ve gone a long way to prevent it.
The Typical Fraud
The median cost of an occupational fraud case was $140,000, according to the ACFE. It goes undetected for a median time frame of 18 months. The most likely way to discover fraud is a tip from an employee who works at the victim organization.
Small Business Vulnerability
Small businesses are the most vulnerable to fraud, because they employ the least amount of fraud prevention controls. Here are just a few quick tips to help prevent fraud in your organization:
Create a culture within your organization that deters fraud and provide employees with education about fraud prevention to reduce rationalization.
Tighten down access to financial areas, segregate duties, and use other internal control best practices to reduce opportunity.
Provide financial literacy programs to employees to reduce need or motivation.
The ACFE recommends that small businesses provide employees with an anonymous way to report suspicious activity.
While we hope fraud never happens to you, it makes good sense to take preventative steps to avoid it. Please give us a call if we can help you in any way.