Internal fraud is a universal and an “evergreen” problem across all industries and cultures. Failure of ethics and the struggles therewith are just part of human nature.
A typical organization loses about 5% of its annual revenue each year due to employee fraud (2014 Report to the Nation on Occupational Fraud and Abuse, by the Association of Certified Fraud Examiners, Inc.)
What is fraud
Types of Business Fraud
Fraud comes in many forms but can be broken down into three categories: financial statement fraud, corruption, and asset misappropriation.
Financial statement fraud or “cooking books”, committed at a higher level of an organization, schemes to omit, misstate, or misrepresent a company’s financial reports with fictitious revenues, hidden liabilities or inflated assets. Even though “cooking books” is less than five percent of fraud cases, it causes the most loss. (https://www.acfe.com/rttn/images/cost-of-fraud-infographic.pdf)
Corruption, such as bribery, extortion, and conflict of interest, constitutes less than one-third of cases where employees use their influence in business dealings for their personal gains at the cost to their companies.
Asset misappropriation, or “theft”, makes up 90% of all fraud cases but is not as costly as the above two, ranging from petty theft to grand larceny, such as pocketing cash from the company’s register before or after it has been recorded, making false expense reimbursement claims, taking supplies, equipment and items that belong to the companies.
Fraud Triangle: Opportunity, Incentive, Rationalization
Opportunity refers to the situations and loopholes that are taken advantage of by fraud perpetrators, over which an employer should have exercised control and supervision, such as:
- Poor leadership: If the C-suite and the board of directors’ leadership examples are lacking ethics, integrity, and honesty, “monkey see monkey do”.
- Weak internal controls: the lack of processes and procedures such as separation of duties, supervision, and documentation of processes can compromise the integrity of accounting and financial information, and give rise to fraud.
- Inadequate accounting policies: Loopholes in how items on the financial statements are recorded can open the door for perpetrators to manipulate numbers.
Incentive, or motivation, refers to the mindset for committing fraud, such as:
- Bending under pressure to deliver expected results, such as meeting or exceeding investors and/or an organization’s expectations for performance, and/or for stock prices.
- Bonuses based on a financial metric, to assess the performance of an employee is usually the revenues and net income numbers. The internal performance pressure created by an organization creates pressure for employees to meet targets, causing them to commit fraud to achieve the objective.
- Personal incentives such as difficulty in paying bills, greed, additions, emotional hurt, revenge towards the employer, etc.
Rationalization refers to a perpetrator’s individual justification for committing fraud, such as:
- “It’s the only way out, or I’ll lose everything,” – the perceived loss of power, position, status, control, a job, unless they commit fraud.
- “Upper management is doing it as well”, bad leadership examples or a poor tone at the top can create followers in the middle and lower corporate hierarchy.
- “I am getting back at the company that treats me unfairly,” an angry or hurt employee commits fraud as his/her way of getting back at their manager or employer.
To be continued in Part 2: “Occupational, Internal and Employee Fraud- how to detect and prevent it (Part 2 of 2)”. Stay tuned!
(The above is based on information from:
A2ZCFO, both the Right and Left Arms for your organization
A2ZCFO takes pride in helping small business owners prepare for either storms or calm weather, and navigate safely through rough waters. As a consulting CFO, I help business owners and management to “keep your ship on course.”
We help with any aspect of financial management from A to Z. By providing trusted financial advice, I create financial and goal clarity, resulting in increases in cash, profitability and sales all the while preparing the business strategically for a successful exit when the time is right.
- Works at client’s location and directly with client’s staff;
- Affordable and flexibility in hours – 4 hours a month to short term full time assignment;
- Excels at messy and difficult clean up situations;
- Meaningful financial reporting for management, bankers, and CPA’s. Tax returns completed by due dates;
- Cradle to grave services – from bootstrapped startups to exit transition service experience.
Please call me (925) 216-5058 or email: rolf@a2zCFO.com
Or follow us on Twitter or LinkedIn: #a2zCFO
A2Z CFO, we keep your ship on course.