12. C’mon, Man!

The following topic will be addressed in this post:

Explain the scope of fraud and why it impacts small businesses to a greater extent than large businesses. What should the owners or managers do to prevent fraud from occurring in the first place?

Unfortunately, criminal behavior exists in business. Among the various classes of criminality we have fraud. In legalese, fraud is defined as “the intentional use of deceit, a trick or some dishonest means to deprive another of his/her/its money, property or a legal right” (Law.com). This definition is broad and includes many activities, but the most important aspect is conscious deceptive action.

According to fraud investigator Tracy Coenen:

“It’s no secret that on-the-job fraud is expensive, costing American businesses an estimated $652 billion each year. The typical occupational fraud will cost a company between $10,000 and $500,000. But this represents only the money taken by the thief, not the other costs that can quickly mount.

The cost of fraud can increase rapidly, costing companies in terms of time, money, productivity, reputation and customer relationships. The prospects of recovery of the proceeds of fraud are dim, with 65% of victim companies recovering 25% or less of the stolen funds. And many recover nothing.”

Beyond the staggering dollar aggregate dollar amount, Ms. Coenen points out three important items about fraud. First, this sum only accounts for the direct costs. Second, indirect fraud costs can climb rapidly and unpredictably. Third, many of the fraud costs are not recouped by firms.

The general public is aware of the larger and more notorious cases, such as EnronMCI, Bernie Madoff, and countless others. The public is not, however, generally cognizant of the impacts of fraud on small business. Because different scales are involved, several thousand dollars of fraudulent activity might be allotted among the annual expenses for a large cap corporation, but the same several thousand dollars may cripple a small business. The small businesses may not have the cash flow to cover the loss or the extra resources to recover the loss through legal remedy.

Why are the annual costs so high and recovery rates so low? Fundamentally, fraud is a crime of intentional action (or inaction), and intent is difficult to prove in a courtroom. Therefore, the best thing firms of any size can do is apply preventative measures. Foremost, even if you are an expert, always acquire the help of professionals for contracts, accounting, general legal counsel, real estate, security concerns, and other specialized business matters. Moreover, find reputable help, either people you know or people who have strong credentials. Also, divide labor. Most fraud occurs because people have responsibility for too many parts (sometimes all) of a business process (Knopp). This situation occurs most often in inventory or financial operations, but the advice pertains for all business processes. To be sure, very small businesses may only have a few team members to cover all business operations. This circumstance reinforces the need for contracting external consultants.

Sources:

Coenen, T. (2008) The true cost of fraud: Direct costs. http://www.allbusiness.com/crime-law-enforcement-corrections/criminal-offenses-fraud/5222152-1.html

Knopp, P.M. (2011) Personal communication with P. Knopp, CPA.

Law.com. http://dictionary.law.com/Default.aspx?selected=785

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