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How To Protect Your Small Business From Fraud

Andrew Beattie

All companies are vulnerable to fraud, but small businesses are particularly vulnerable because decision-making and other responsibilities are often concentrated in a few key positions. In this article, we'll look at the fraud risks a small business usually faces and how to avoid (or at least reduce) them.

Internal Fraud and External Fraud
The fraud facing any business can be split into two types, internal and external. Internal fraud is generally employee or partner fraud. This includes skimming, redirecting and misappropriation of funds, and outright theft. Internal fraud can be one bad employee or a conspiracy of many.

External fraud is fraud that involves at least one outside party and often includes and internal element. External fraud can be as complex as vendor accomplices who overcharge the business and give the employee handling the account kickbacks to stay quiet or as simple as customers passing bad cheques or using stolen credit cards. Nothing can eliminate all risk of fraud from a small business, but there are some steps that can be taken to limit the exposure.

Do the Due Diligence
Hiring employees can be a headache for any small business owner, especially now that the Internet has armed people with the tools to turn even the most basic resume into a case study on how to spin menial labor into a PhD worthy job description.

Although it is reasonable to assume that the references are similarly useless in judging a potential employee's character, it is well worth your time to actually dial them and have a conversation. While they may not be entirely forthcoming, you can tell a lot by what they do (and don't say). How long have they known the applicant? How much instruction does the applicant need to learn a new task? These don't have to be brilliant questions, they just need to stretch out a conversation long enough for any red flags to naturally emerge.

The more responsibility an employee has in the business, the more due diligence is required. If you are hiring someone who will be doing the books and handling deposits, do the complete background check.

Divide and Verify
Whether it is the till receipts or the quarterly numbers, no single employee should have too much authority. Ideally, the person taking in the money shouldn't be the person cashing them out and making the bank deposit, but the reality is that a small business often requires doubling up roles.

If you can't separate functions and build oversight into the process, set up regular internal audits to be done together or even with an outside certified public accountant (CPA). Knowing that audits are going to take place will likely discourage most people from risking it and will uncover fraud before it becomes endemic. Until you have enough employees to split it up or the capital to pay for regular outside audits, you will need to personally verify of invoicing, deposits and other vital finances.

Set Clear Boundaries
Writing down a code of ethics can be difficult for small business owners who would prefer to believe that there are shared values that don't need to be recorded like third grade classroom rules. However, writing down and having everyone agree to the same ground rules is necessary in two important ways. One, it sets clear expectations. For example, do you consider taking stationary home grounds for dismissal? Is padding the mileage report acceptable with a certain range? There are no right or wrong answers, but writing it down protects you from misunderstandings and protects your employees from saying one thing and enforcing another. The second function of having a code of ethics is to strengthen your court case if you do have to take legal action.

Once you have the your code of ethics worked out, it is vital that you enforce them and have procedures to follow when the rules are clearly broken. The first step for any breach is to document it and, if it is serious, contact a lawyer to guide you through the proper steps. If you don't feel it is dismissal territory, keep documenting it and retain a lawyer anyhow. As vulnerable as small businesses are to fraud, they are even more susceptible to wrongful dismissal suits. The last thing you want to do as an owner is to drag an employee into your office and start yelling about how they betrayed your trust.

The Bottom Line
Running a small business is hard enough without having to worry about everyone trying to rob you blind. Fortunately, you don't have to abandon all your faith in humanity – you just need to take some steps to mitigate your exposure. Put in the homework when hiring, break up important responsibility and set up oversight, and set clear expectations of what will and will not be tolerated. You won't eliminate all your risks, but you will be putting up serious deterrents and setting the groundwork for your legal recourse if you do fall victim.

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