Stay on Top of Business Fraud Prevention by Watching for These 6 Red Flags

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Business fraud could cost your company upwards of $350,000. No business can afford that, which is why you need to watch for these warning signs.

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NOTE: This article is intended to inform our readers about business-related concerns in the United States. It is in no way intended to provide legal advice or to endorse a specific course of action. For advice on your specific situation, consult your legal counsel.

In “Ocean’s Eleven,” nearly a dozen con men combine their wits, acrobatic skills, and cool cars to rip off a casino in extravagant fashion. The casino owner only unravels the intricate scheme shortly after the anti-heroes have made off with millions.

The good news for most business leaders, however, is that if your business gets ripped off, the evidence will be much easier to uncover by using your accounting software and keeping an eye out for a few warning signs.

Is business fraud prevention really that important?

Business embezzlement is a big problem.

Hiscox, a specialty insurance global provider, surveyed 200 U.S. accounting and finance professionals who have worked at a company where embezzlement has occurred for its 2018 Hiscox Embezzlement Study. That study found that the average embezzlement case went on for more than two years and cost the involved companies an average of more than $350,000 but that more than 50% of the companies ultimately recovered less than one-third of what was taken.

This isn’t a few pads of sticky notes and permanent markers we’re talking about. The Association of Certified Fraud Examiners found that 22% of fraud cases caused losses exceeding $1 million. Embezzlement can take the form of everything from tip jar skimming to complex payroll fraud. And these numbers reflect known cases, without accounting for situations in which the embezzlement was never discovered.

the most common embezzlement techniques

The most common embezzlement techniques, according to a Hiscox study

Business fraud can be especially devastating to small businesses, for which cash flow issues are the leading cause of business closure. And the smaller the business, the more devastating fraud can be.

A $100,000 embezzlement case may lead to unpleasant litigation for a large corporation but could be crippling for a mom-and-pop shop. Small-business leaders generally have less experience running a company than midsize and large business leaders, and small-business employees have less oversight and more autonomy across business functions.

Small businesses also lose almost twice as much ($200,000) in the average embezzlement case as midsize and large businesses ($104,000), according to the Association of Certified Fraud Examiners.


6 business fraud red flags to watch for

Regardless of your business size, you need to have a plan in place to prevent business fraud. The accounting and finance professionals who responded to the Hiscox survey found that—beyond just money—the fraud their companies dealt with cost them employees, customers, business partners, and reputation, wounds that will eventually bring down businesses of any size.

But enough doom and gloom. Let’s look at some strategies you can use to sniff out fraud before it brings your business to its knees.

1. Company funds are being transferred to/from countries you don’t do business with

Why it’s a cause for concern: Embezzlers can transfer company money overseas to launder it, then return it to a personal bank account with a muddled trail.

Example: You notice a credit in your account from Canada, even though you don’t have any customers or clients from there.

What you should do about it: Review your books at least once a month. If money is going to or from a source/destination that you’re not familiar with, investigate, even if an employee tells you it’s legitimate.

2. Employees are paying vendors or other employees with cash

Why it’s a cause for concern: Cash payments don’t leave a paper trail, allowing embezzlers to cover up fraudulent activity.

Example: One of your supervisors insists on paying a supply vendor (who just happens to be one of his old high school buddies) in cash because that’s how the vendor prefers to be paid.

What you should do about it: Insist that all company business is conducted using checks or company debit/credit cards (save for the smallest of incidentals, such as tipping a pizza delivery person). If you hear an employee is making cash transactions for business purposes, investigate.

3. You spot vague business deals that lack a clear purpose

Why it’s a cause for concern: Embezzling employees can set up sham deals with outside accomplices to make fraud appear like legitimate company business.

Example: One of your managers sets up a nebulous “consulting” gig for their brother-in-law that pays a retainer of $1,000 per month.

What you should do about it: Require all employees to provide a clear and worthy business case for any and all business deals, and regularly check to ensure that those deals are still providing business value.

4. Employees are making deals with vendors that haven’t been approved through proper channels

Why it’s a cause for concern: Embezzling employees can bypass normal checkpoints to set up fraudulent deals with sham vendors by going over the heads of management.

Example: You come in on Monday morning to hear from one of your employees that they set up a new purchasing contract with a parts supplier that you’ve never heard of. The deal seems too good to be true.

What you should do about it: Institute a policy for all business deals requiring approval from multiple managers.

5. Your books aren’t balanced

Why it’s a cause for concern: Balanced books are the healthy pulse of any business. If you have money coming or going out that you can’t account for, it means that someone at your company is up to something or your accounting is sloppy. Neither situation is good.

Example: You check your books at the end of the month to find that you’re $1,500 short with no explanation.

What you should do about it: Check your accounting software every day to make sure that everything is accounted for. The software will alert you when something doesn’t add up.

6. Business and personal expenses aren’t being separated

Why it’s a cause for concern: Using a corporate card to pay for personal expenses is a big no-no, even if the employee pays the company back. It muddies the waters and makes it more difficult to spot embezzlement when it does happen.

Example: You have an employee who keeps “accidentally” putting gas in her personal vehicle on the company credit card, even though she pays you back in cash.

What you should do about it: Enforce a strict policy that only allows legitimate business expenses on your company credit cards. This will also save you from having to sift through expenses at tax time. Some expense reporting software even allows receipt scanning.


Portrait of an embezzler

While the following signs could have many different, innocent explanations, the Hiscox and ACFE surveys found that embezzlers commonly:

  • Live a lavish lifestyle clearly beyond their means (for example, suddenly showing up to work in a new luxury car).
  • Show reckless behavior (e.g., excessive gambling, racking up speeding tickets, overusing PTO).
  • Become disgruntled at work if they feel they have been treated unfairly.
  • Show control issues (e.g., an unwillingness to share their duties with assistants or temporary fill-ins).
  • Suffer from financial difficulties.

None of these behaviors are grounds to accuse an employee of embezzlement, but—when combined with the red flags outlined above—they’re worth keeping an eye on as part of a bigger picture.

Though it may seem reasonable to be more suspicious of newer employees who haven’t proven themselves yet, embezzlers have—on average—been with their company for eight years.

That’s because such employees have generally had time to become familiar with the workings of a business, have suffered a real or perceived slight that motivates them to try to collect amends, or even recruit accomplices to help them commit fraud (the average number of people involved in a given scheme is three).


What to do when you identify business fraud

Preventing significant fraud or embezzlement at your business starts with hiring the right people, treating them fairly, and knowing the signs to look out for.

But what do you do if you’ve spotted obvious signs of fraud and need to take action? Hiscox recommends:

What to do What NOT to do
Set up an investigation team made up of managers, and recruit outside help, if necessary. Keep detailed notes throughout the investigation. Don’t jump to accusations. Even if there’s only a tiny chance that someone is actually innocent, follow due process. A false accusation can do irreparable damage to the relationship between the employee and your company, and your company could be sued.
Review the records in your accounting software to pull evidence. Don’t interview possible accomplices together, and don’t interview suspected employees by yourself. Have an HR rep on hand for all interviews, and record clear notes of what was asked and what was said.
Once you have sufficient evidence of embezzlement, contain the damage by restricting the fraudulent employee’s access to company finances. Don’t reveal your suspicions before you have solid evidence. Gather as much evidence as you can before making your investigation known. A suspected embezzler can delete emails or clean up financial records if they find out you’re on their trail.
Identify the source of the breach that allowed the embezzlement to happen, and fix it. If you don’t already have a fraud reporting hotline (phone and/or email), now is the time to set one up. The Association of Certified Fraud Examiners study found that 40% of fraud cases are uncovered by whistleblowers, followed by internal audits (15%) and management review (13%). Don’t try to take the law into your own hands. Give law enforcement your full cooperation to help them do their job, and if you’re worried about negative exposure, talk to your attorney about how to proceed.
Praise and protect the whistleblower, if you were tipped off by an employee.

Business fraud prevention is just one piece of the small-business accounting puzzle. To stay on top of a wide variety of business accounting topics—from when it’s time to upgrade your accounting software to how to file your taxesfollow our accounting and finance blog.

Looking for Accounting software? Check out Capterra's list of the best Accounting software solutions.

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Andrew Conrad

Andrew is a content writer for Capterra, specializing in church management and project management software. When he’s not striving for the perfect balance of information and entertainment, Andrew enjoys the great outdoors and the wide world of sports. Follow him on Twitter @CapterraAC.

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