Internal Fraud Prevention

How to Prevent Internal Fraud

We see it in the newspapers every few months:

“This great little business just got taken for tens of thousands of dollars by an employee/ contractor/ friend/ family member.”
“We trusted them implicitly.  They were like family.”
“We feel so betrayed.”

Internal fraud happens to small businesses every day, but it does not have to happen to yours.  Here are some common types of internal fraud, and some easy measures that can be taken to ensure that there is simply no opportunity for theft in your business.

internal fraud

Understanding and defining theft.

What do you call it when something takes something from you without asking?  That’s stealing!  Why would anyone do that?  You might be amazed what actions can be justified depending on the circumstances.  Big problems often start small, so where do you draw the line?  “My boss is really giving and easy going.  She won’t mind if I take home a pad of Post-Its.  I know she would let me if I asked.”  Did the employee ask?  No.  So is that stealing?  YES!  The difference between that small example and a BIG problem comes down to three things: Opportunity, Rationalization, and Motivation.  We call this the Fraud Triangle.  It is your job as a business owner to eliminate the opportunity.  Keep reading to find out how.

Set the right corporate culture.

Many people drive around 5 miles over the speed limit on a regular basis, but do you know people who drive 40 miles over?  Why not?  Any amount over is still illegal, right?  The reason is because 5 miles over has become socially acceptable.  By creating a permissive environment where everyone knows they can get away with something, an alarming number of people will take advantage.  That permissive environment creates Opportunity.  The Rationalization may be that “it’s no big deal” or “it’s not going to hurt anyone.”  The Motivation could be anything from “I’m late!” to “It’s fun!”  The point is, in order to prevent theft of any kind in your business, there needs to be a Zero Tolerance Policy to any form of theft or fraud.  Make sure this is clear in your employee manual.

Who could do such a thing?

Keep an eye out for employees that are living beyond their means, having financial difficulties, exhibiting control issues, acting unusually close with customers or vendors, displaying a wheeler-dealer attitude, going through a divorce or family problems, acting irritable/suspicious/defensive, displaying addiction problems, or refusing to take vacation.  These are all signs that there may be something going on under the surface.

Most common types of Fraud.

  • Over a third of internal fraud cases are due to corruption, where the fraudster uses their influence in business transactions to violate their duty to the business for personal gain.  This can include things like conflicts of interest, such as a non-profit board member using charitable funds to purchase goods or services from his personal business.  It would also include bribery, illegal gratuities, and extortion.
  • Almost a quarter of internal fraud cases are due to billing schemes.  This generally involves false invoicing either through a fictitious company or using the name of a legitimate vendor.  The bills and bill payments get entered into the books, but the checks are either being written to the employee or a company they own.
  • Almost a fifth of internal fraud cases are non-cash thefts.  This can include stealing inventory or other tangible assets for personal use or to sell or profit, sometimes even having products shipped directly to a home address.  Unexplained entries, altered records, fictitious sales, and write offs are good clues that there may be a problem with company property walking off.
  • Other common internal fraud types include: skimming, expense reimbursement, payroll fraud, check tampering, cash on hand manipulation, cash larceny, financial statement fraud, and register theft.

What do all types of fraud have in common?

All types of fraud are almost 100% preventable.  Proper internal controls and separation of duties will eliminate the Opportunity for fraud in your business.  How do you know if you can trust someone?  Make sure everyone knows that there is no chance to take advantage, and don’t give them a reason to want to.

How do I stop fraud from happening to me?

  • Have a good anti-fraud policy in your employee manual, and an anonymous tip system.  Over 40% of fraud cases are discovered because of tips from co-workers.  Train your employees and managers to keep an eye out for issues, and set up a culture of Zero Tolerance.
  • Use proper internal controls with oversight and separation of duties.  For example, if you must have an employee sign checks, make sure there is another person who is responsible for reconciling the bank account and verifying that all checks are legitimate and made out to the correct parties.  Make sure that mail is being opened, reviewed, and documented either by the business owner or by an employee that cannot benefit from its contents, and have clear systems in place for what departments handle which issues.
  • Do regular management reviews.  Never trust anyone so much that they are beyond supervision.  Cross train roles to occasionally change things up so that there is more opportunity to notice when there may be an issue, and no one becomes “irreplaceable.”
  • Conduct occasional internal audits.  Make sure that the highest people in the company always have access to the bookkeeping software without needing to go through the employee doing the entries.  Hire an outside accountant or fraud examiner to do periodic reviews.
  • Educate yourself.  The information in this article is just the tip of the iceberg.  There are lots of free resources available, and we are happy to help you find the ones that are the most pertinent to your business and situation.

Where do I get more information?

  • Google it.  There is tons of great information at our fingertips.
  • Check out for more great educational resources for small businesses.
  • Ask for help.  Your accountant, bookkeeper, business coach, attorney, or financial planner should all be thrilled to point you in the right direction.  If they are not thrilled, make sure you look into what they might be up to.

Make sure to check out this Polymath Blogpost for a discussion of external fraud.

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