By Steve Cleland, an EO Los Angeles member and partner of  Beach Freeman Lim & Cleland, LLP.

“This is the last person I would have expected this from. They were like family to me.”

In most cases, that’s the first phrase uttered to me when a company discovers employee fraud. I have seen it happen too many times.  A long-time, well-trusted employee embezzles cash over a period of years. It usually starts off in small amounts and grows with increasing fearlessness. By the time it is caught, thousands (sometimes millions) of dollars are lost.

The harsh reality is that for every embezzled dollar, it will take anywhere from US$3-$20 dollars in additional collected revenues to replace it. No matter how much is taken, fraud has a devastating impact on business and business owners. It happens in companies of all sizes, though it happens much more frequently to small companies (less than US$100 million in revenues). 

This is a serious problem that is not going away. In fact, recent data from the Association of Certified Fraud Examiners indicates that the problem is only getting worse. In desperate times, like the kind we’re currently facing, the problem will likely become much worse.  Many owners want to think “not my employees,” but it is this sort of blind trust mixed with a lack of internal controls (policies and procedures aimed at preventing errors and fraud) that can open the doors to trouble.

The number one reason people embezzle from their firm is because they can. Many business owners make it too easy. A well-designed and functioning internal control system is the number one defense against both errors and fraud.

Internal Controls
There are three components of a successful internal control system. All three must be in place and functioning for the system to function effectively. They are (1) control environment (the company’s emphasis on control and quality), (2) control policies and procedures, and (3) monitoring and adjustment.

Warning Signs
Fraud schemes are uncovered in various ways, including internal control systems, an employee tip or an owner/employee accidentally stumbling upon the scheme.  In general, the signs are often there, but someone must be paying close attention and any warning sign must be followed-up.

The following are strong signs of possible fraud and in most cases that I have been involved in, these were happening for several months and were not addressed:

• Bank reconciliations not being done on a timely basis or at all.
• Extremely late financial reports.
• Consistent errors in financial reporting.
• An employee that will not take vacation.
• An employee living beyond their means.

Fraud is very prevalent in businesses today. Growing entrepreneurial companies can be easier targets than other businesses because of a thin administrative structure, the “trust” element and the fact that entrepreneurs are just too busy building their businesses to pay attention to the warning signs.

It’s important entrepreneurs don’t fool themselves by having a “not me” mentality. By minimizing risks today, before it’s too late, business owners can sleep better at night knowing that they are doing something to prevent their company from being a statistic.