In setting up your new business, fraud is probably one of the last things you will think about. Unfortunately, it's an issue that needs more attention than we would like to realize. In order to try to simplify matters for the small business owner, I have narrowed the business treatment of fraud into three steps: Identifying weaknesses, implementing prevention procedures, and consistently following those procedures. In this article, the word "fraud" is used to describe both "an intent to deceive" and "theft." In most definitions these two descriptions do not mean the same thing but, for our purposes, we will assume they are used together to commit a wrongdoing toward a business.

I was introduced to fraud at the young age of 20. I was a trusting, naïve soul in a very tempting chicken coop - a bank. The fox, a friend and coworker, was caught diverting small amounts of interest on a regular basis from each of hundreds of certificates of deposit into an account falsely labeled with her as the sole signer. She had been pilfering the money for almost two years before she was caught. I was flabbergasted! She was so likable (and she gave my husband and I such a lovely wedding gift!).

Fraud is one of those criminal acts that we assume will never happen to us. We all like to think of ourselves as good judges of character in choosing employees as well as friends. We believe that in our small business setting fraud is highly unlikely to occur. Think again! Most individuals who choose to commit fraud are some of the most likable people you will ever meet. Rather than finding out that your trusted vendors, customers, or employees have taken advantage of your trusting nature, follow these steps in the formation or early months of your business in order to discourage any potential wrongdoing.

Step one: Determine, with the help of your accountant and legal advisor, what the weaknesses are in the operations of your particular business. Businesses are as variable as the people who run them. With that in mind, no two operations will have the same risks, but some problems tend to be consistent no matter what the business. Weakness in hiring practices is one of the best examples that happen to almost every business. Do you check references? Are you sure they're not rigged? Is the employment history truthful? As the saying goes, "The closest a person ever gets to perfection is on their resume." Be very thorough in analyzing your business for problem areas. Even if you decide that a fraud prevention procedure is not feasible for a particular weakness, you are still aware of the gap, and will pay extra attention to it as you review your process.

Step two: Set up fraud prevention procedures to follow in every weakness that you have identified in your operations. Discouraging fraud is a matter of removing the temptation to steal. In small to medium-sized businesses, this does not have to be a large or expensive procedure. These measures can be as simple as separating duties in dealing with cash receipts. For instance, make sure that the person who balances the bank accounts is not the same person who signs the checks or makes the bank deposits. Using this simple division of labor discourages misconduct by making any irregularity very noticeable: the employee knows it is too easy to be caught and, therefore, does not steal. There are a number of dual or triple control actions that your accountant can recommend. All good auditors check for these controls automatically is assessing the internal control of a business.

Step three: Follow your protocol on a regular basis without giving in to the temptation of using shortcuts. Shortcuts save time but lack security. If your procedures are not followed all of the time you may as well not be doing them at all. This is especially tempting when you have a very small business and you trust everyone involved.

You have known Sally, your bookkeeper, for years. You have no problem allowing her to sign the checks, make out the deposits and do all the bookkeeping. Her financial statements look great and the business is doing terrific - on paper. Then Sally disappears with $200,000. Perhaps you didn't know Sally as well as you thought you did. On the other hand, given the temptation, you gave Sally an opportunity that few people could resist. Either way, you're out $200,000! The goal here is to eliminate the temptation, not to suspect every coworker and employee of potentially being a thief! I firmly believe that, overall, most people are inherently good and have good intentions. However, when you hand someone a huge temptation, it's as good as an engraved invitation to take advantage of you.

Being aware of the potential of fraud in any situation is the first weapon you have against it happening to you. Be proactive! Seek out help from your accountant and legal advisor. Find those weak spots and read up on fraud and theft in the areas that affect your business the most. Make sure you introduce procedures in order to lower the level of temptation for those who work with and for you. Moreover, stay consistent. Your security procedures will only work if you and your coworkers use them all of the time.      

                                  - A. Kris Bell

See our related article on Fraud and Theft "Hope for the Best and Insure the Rest!"