Most companies have taken aggressive steps to cut costs, improve productivity, and limit risks to remain profitable. But none of those steps addresses the threat of business fraud, a crime that cost U.S. businesses an average of 6 percent of annual revenue in 2002, according to the Association of Certified Fraud Examiners (ACFE). That translates into about $600 billion lost to a variety of fraud schemes—most of which are perpetrated by employees or other company insiders. And the losses are greatest at companies that lack ongoing audit programs and are most common at privately held companies.

Fraud experts say most business owners continue to believe the problem won’t happen to them. “What a lot of people don’t understand is that fraud isn’t just limited to big companies,” said James Blanco, a former U.S. Treasury Department investigator and author of Business Fraud: Know It and Prevent It. “In medium-size companies, something as basic as a bookkeeping scam can be a killer.”

Blanco’s point is supported by a growing body of evidence. For example, in its 2002 “Report to the Nation on Occupational Fraud and Abuse,” the ACFE reported mid-sized companies—between 100 and 999 employees—suffered the greatest average loss: $135,000, accounting for 20.1 percent of all fraud cases, followed by:

• Small businesses—fewer than 100 employees—suffered an average loss of $127,500 but accounted for the largest share of fraud cases (39 percent).
• The largest companies—more than 10,000 employees—suffered an average loss of $97,000 but accounted for the smallest share of the cases (17.5 percent).
• Medium-to-large companies—1,000 to 9,999 employees—suffered the smallest average loss ($53,000) and accounted for 23.4 percent of the cases.

Meanwhile, research by the American Institute of Certified Public Accountants (AICPA) indicated companies conducting regular audits—a step some businesses often avoid for cost reasons—had median fraud losses 35 percent lower than those with no internal or external audit function.

Business frauds typically fall into three major categories:
• Asset misappropriations, which encompass about 85 percent of all frauds, can include payroll or bookkeeping scams, cash skimming, check schemes, or fictitious refunds.
• Corruption often involves kickbacks or bribery within a company’s purchasing function. While corruption accounts for nearly 13 percent of all fraud cases, experts warn it’s often the most difficult to uncover since it typically includes collusion with illegal money transfers that take place outside the corporate books.
• Fraudulent statements, which can range from overstating revenues to underreporting liabilities or business expenses, are by far the most costly type of fraud, causing an average loss of $4.2 million. Because audits are one of the best tools to uncover statement fraud, businesses that don’t conduct regular audits are usually most vulnerable to this type of scheme.

In addition to regular audits, a checklist of basic measures to help companies and employees prevent fraud include:

• Improving hiring practices. Experts say the way in which a company evaluates, screens, and hires new staff sends a strong message to both prospective and current employees. While 75 percent of all companies perform basic reference checks, according to a 2003 study by the Society for Human Resource Management (SHRM), the gap between large and small organizations widens when comparing verification on educational credentials, criminal background, and specific work history. For example, less than half of small companies verify an applicant’s educational background, while 77 percent of large firms take that step.

• Offering anonymous reporting systems. The 2002 ACFE study reported that tips from employees, vendors, or customers were the most common means by which companies detected cases of fraud. That same study reported that firms providing employees with confidential fraud hotlines, operated by third parties outside the company, cut average fraud losses by 50 percent.

• Separating bookkeeping functions. Since the majority of asset misappropriations occur when employees have too much access to the revenue and expense sides of a business, experts suggest no one person handle both roles. Effective staff cross-training and enforced vacations can help prevent potential problems.

• Involving a board of directors. Typically, this involves creating an audit committee of the board or expanding the role of an existing committee to include regular oversight of corporate anti-fraud and audit activities. This step not only allows business leaders to tap the expertise of board members, but also demonstrates to both management and employees that fraud and appropriate internal controls are taken seriously.

• Creating a strong ethical culture. In most mid-sized businesses, a high level of trust among co-workers often can include overlooking so-called “little things,” like taking office supplies for personal use. Businesses that develop appropriate ethics policies and written guidelines for acceptable behavior—and adhere to a “no exceptions” enforcement policy—can head off problems before they occur.

“Over the years, I’ve heard from business owners, ‘We don’t need a policy because we’re like a family here,’” said Blanco. “Well, I can’t tell you how many times I’ve uncovered frauds where a member of the so-called family had ripped off the business.”

In fact, the ACFE study found privately held companies, which are often family owned, accounted for the greatest share of fraud cases: 31.9 percent. By viewing fraud as a serious issue and taking steps to enable your managers and employees to spot and report it, you can greatly reduce the odds that your company will be victimized by an inside attack on the bottom line. IBI