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With a potential recession on the horizon, we know you want resources to help your business master the moment. We've put together our Agility & Excellence Resource Center to bring you strategies and solutions with a finger on the pulse of what's ahead.
It’s like a law of physics: when the economy slows down, fraud tends to go up. Mounting financial pressures increase temptation among workers, vendors and other bad actors seeking quick gains. For organizations already battling significant resource constraints, the blow could be crippling.
Businesses lose an estimated 5% of their revenue annually to occupational fraud. Most of this fraud is committed by employees, with an average loss of $1.5 million last year for organizations in the U.S. and Canada, according to a recent analysis by the Association of Certified Fraud Examiners (ACFE).
“In a slowdown, if profits are lower, you have people who were expecting to get more suddenly getting less,” said Jeffrey Bussell, Director of Operations for CBIZ’s Forensic Consulting Group. However, detecting employee or vendor fraud may not be a top priority for companies grappling with slowing demand or higher costs tied to rising inflation, he said. “When there’s a downturn, you’re so focused on filling your bucket — but what you’re not doing is looking to see if there’s a leak at the bottom.”
In what follows, we’ll lay out the critical factors that can leave your organization vulnerable to fraud — and steps you can take to guard against it in a slowing economy.
Vulnerability in a Downtown
When business conditions get tougher, cutbacks or turnover can weaken backstops against fraud. For example, if an organization eliminates some positions because declining profits — or delays in backfilling empty roles — this could result in fewer checks for discrepancies in areas like payroll.
A bad actor inside an organization could potentially take advantage of those gaps to increase someone’s pay rate, or issue a bonus or commission “that you might not otherwise be entitled to, because nobody’s really reviewing it,” Bussell said. Such schemes could also include paying someone who no longer works at the business in question. In that scheme, a former employee is reactivated in the payroll system, with the mailing address or direct deposit information changed to that of the fraudster. “If you’re at a big company with a large payroll, you could blame it on turnover if anyone ever asks.”
External forces such as inflation or supply-chain disruptions can also provide an opportunity for fraud, both internally and externally. An employee might approach a vendor and ask them to pad invoices, promising to approve the extra costs in exchange for a cut of the proceeds. Suppliers might also send through duplicate invoices, or bill customers for work they haven’t yet performed.
These moves are often harder to spot at times of economic volatility. During COVID-19, for instance, the price of materials like steel and wood soared. More recently, inflation has led to sharp increases in the cost of everything from food to fuel. When costs rise on multiple fronts, distinguishing between legitimate and fraudulent increases can be more challenging, especially for short-staffed businesses. Some companies may never even detect the fraud, attributing the missing money instead to lower sales in a difficult economy.
Run the Numbers — And Bring in a Fresh Set of Eyes
One of the most effective ways to detect fraud is simply to compare financial changes over time. Run an annual or periodic profit and loss (P&L) statement summarizing your organization’s revenues, costs and expenses over a certain span of time, and see what stands out. Big fluctuations in categories such as rent, utilities or other relatively fixed costs (vs. entertainment or marketing expenses) could indicate a problem.
Bussell also recommends conducting periodic analyses of vendor spends to check for anomalies. There may be a good reason for a cost hike, especially at a time when prices are rising rapidly. Drill down further to make sure these increases reflect broader market trends — and your contract or agreement with that vendor, he says. “Did they change the terms to see if anyone notices?”
Another effective tool for fighting fraud: having people in charge of money swap roles. Fresh eyes on the books can help spot irregularities, Bussell said, adding, “I’ve seen that be really effective.” For example, management could take a person with one set of accounts and switch them over to work with another’s group of clients.
Fraud is an unfortunate reality of doing business. However, being transparent about compliance efforts, providing tools to report suspicious behavior and setting up internal controls, such as fraud training for employees and formal risk assessments, can bolster your company’s defenses.
“It takes people, time and money to prevent fraud,” Bussell said. “But one of the most important tools costs nothing: reminding your employees that fraud is investigated, and that their job is subject to periodic checks.”
He suggests setting up whistleblower programs to enlist the help of people who want to do the right thing. Fraud losses were two times higher at organizations without hotlines, ACFE found, and employee training programs significantly increased the likelihood that fraud will be reported.
If you suspect something’s not right, consider bringing in an outside accounting professional to evaluate the situation. Fraud risk assessments and audits examine the controls your business has in place, and how easily they can be thwarted.
Such partners can also flag behavior that may be improper but not illegal, providing a perspective on potential vulnerabilities and recommendations for critical areas to improve safeguards, Bussell said: “Let us be there to talk to you about it.”The Fraud Triangle
Source: ACFE Insights
A concept known as the fraud triangle provides a useful framework for spotting high-risk situations, based on the following three factors:
- Pressure. The financial or emotional force pushing toward fraud. This could involve personal economic circumstances, corporate pressure tied to market incentives, and job cuts or pay reductions—all of which can be exacerbated in a downturn.
- Opportunity. The ability to execute a plan without being caught. Economic slowdowns can create additional windows, for example, if companies cut budgets for compliance functions or lack sufficient staff or accounting controls to detect fraud.
- Rationalization. Personal justification of dishonest actions. Individuals may view this as payback for being poorly treated, or fear losing their job unless they commit fraud to hide poor results. Others cite bad behavior by upper management as justification.
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