How to Prevent Fraud in Your Small Business

Most small business owners don’t even consider that their employees could be stealing from them until it’s too late.

The average small business fraud lasts 24 months and costs $200,000 by the time it is discovered according to the 2008 Report to the Nation from the Association of Certified Fraud Examiners (ACFE).

Three former employees of PBS&J, a Miami engineering firm, pleaded guilty in federal court to their roles in embezzling 36 million dollars in a scheme that lasted more than 12 years. (According to a report by the Miami Herald on September 29, 2006.)

The average American business loses 7% of revenue (sales) to fraud – more than the total profits in many small businesses. There are five main causes of a higher incidence of fraud in small businesses.

1. Trust. Small business owners tend to be closer to their employees, know them personally as well as from a business standpoint. For an employee to steal from you, you must trust them. Employees tend to be more trusted in small companies.

 . Small workforce. With a small number of employees, many business owners believe that controls are impossible. This isn’t true. Even with a small number of employees, some controls can be implemented. Even a small number of controls can reduce the likelihood of fraud. For example, the ACFE report indicates that companies with a job rotation / mandatory vacation policy had 61% lower fraud losses.

3. Failure to delegate. Small business owners tend to want to be in control. As a result, employees are hired, given a job, but the owner retains important parts of the job for themselves. As a result, there appear to be controls. Unfortunately, the owner has over burdened themselves with too many tasks; and, as a result, they do a poor job in executing them. For example, signing checks without thoroughly reviewing documentation.

4. Overlapping and unclear job responsibilities. In a small business, it often seems that everyone is responsible for everything. If a job needs to be done, everyone is expected to pitch in. Unfortunately, this provides an opportunity for a dishonest person to overcome controls by being able to work in more than one part of the business.

5. Controls not a priority. Finally, controls just seem not to be a priority for most small business owners. There is a pervasive “it can’t happen to me” attitude. Unfortunately, it can happen to you! Spending some money now to install a number of preventive controls should be seen as an investment (no different from an insurance policy), not as an expense. Like insurance, you hope you will not need it – but if you do, controls can be there to help.

A former Home Depot employee pleaded guilty in New York federal court to taking millions of dollars in kickbacks from vendors to ensure their products would be stocked by the company. He shared more than $2.5 million in bribes with other company employees in a scheme that extended over three years. (According to a report by Reuters on June 30, 2008.)


1. Acknowledge the possibility it could happen to you. Fraud against business is widespread and most business owners don’t realize it until it is too late. 

2. Become aware of common fraud indicators. There are many indicators of fraud. Business owners need to become aware of these red flags and watch for them. They do not always mean fraud is occurring, but they do mean that heightened monitoring may be needed.

3. Review and strengthen internal controls and take other anti-fraud measures. There are many measures that have proven effective in reducing fraud opportunities and providing deterrence. The business owner should become aware of the most common controls and other measures for their particular type of business.

4. As the business owner, take personal responsibility for continuous monitoring. In a small business, the owner themselves must accept responsibility for anti-fraud efforts and monitoring. Trusting an employee with this critical task can be a big mistake if that employee turns out to be a fraudster. The ACFE Report also shows that the higher a person is in the organization and the longer they have worked there (in other words, the more they are trusted), the larger the frauds they commit before being caught. 

A 63 year old man working as Director of Financial Services for a non-profit organization, pleaded guilty in federal court to diverting more than $400,000 in incoming checks payable to the non-profit into a dummy bank account. (According to a report by the Washington Post on September 24, 2008.)

Where to Get Help

Internal Audit. If you are a larger business, a first line of defense should be your internal audit department. Public companies are required under Sarbanes-Oxley to have internal audit report directly to a committee of the Board. But even if you are not a public company, internal audit should report directly to the top. The department with the most fraud incidents is accounting, so it generally does not make sense to have internal audit within the accounting or finance functions.

Company Attorney. It is important to actively involve the company’s legal counsel in any anti-fraud programs or suspected fraud investigations. If you are a larger company, this should be your corporate counsel. If a smaller firm, you need a reliable outside attorney experienced in this area to guide your preventive and reactive actions.

External CPA. Many CPAs have been trained and have experience in reviewing controls and recommending improvements. This can be a stand-alone assignment, or will be done as part of an audit. Remember that accounting controls focus only on the accounting system. Additional types of controls are needed in other areas to effectively reduce fraud opportunities. It is important to understand that an accounting audit is not designed to find all fraud, nor is it likely to.

Certified Fraud Examiner (CFE). CFEs are specifically trained and experienced in the area of fraud prevention and investigation. They may also have additional backgrounds in accounting, law enforcement, or other fields.

If You Suspect Fraud

When a business owner (or manager) suspects that an employee is stealing from the company; the most common reaction is emotional. You probably want to call them into your office, confront them, and fire him or her. In most cases, this reaction will only cause additional headaches and possible financial losses.

In general, it is usually best to keep your suspicions to yourself until after you have consulted with a qualified professional and legal counsel. There are many possible issues to consider before deciding on a course of action.

Even if the employee actually did steal from you (and we generally don’t know that for sure yet), the legal system provides them with numerous rights. Get professional help immediately so you don’t expose yourself to potential liability.


A hospital warehouse supervisor in Spokane, Washington pleaded guilty in federal court to collecting more than $600,000 in his PayPal account by selling stolen hospital supplies on eBay. The fraud continued for more than three years. (According to a report by the Seattle Times on December 21, 2006.)

If you are a business owner, the time to act is now, not after you have incurred a large loss. Go back to the four steps in the prevention section of this article and begin to implement these now.

Not sure how to go about it? The right professional assistance may prove to be a wise investment.

As a final thought, remember that although controls may in some instances deter fraudsters; they cannot stop a determined thief. A strong and ongoing monitoring program is critical to detecting frauds earlier, before they have grown into major losses.

Good luck in your business and in your fraud prevention efforts!

Source by Raymond Kulzick

Diana McCalpin is an accountant who manages a Certified Public Accounting Practice in Laurel, Maryland which performs audit, accounting and tax services to customers. She loves to share information with clients to help them grow their businesses and be profitable.

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