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To Prevent Fraud, Small Business Needs To Tighten Payroll Controls

Steps and advice on how to avoid fraud

Written By: Jerry Carter, CEO

Small businesses, those with under 100 employees, are the most vulnerable to fraud according to the Association of Certified Fraud Examiners. And while fraud can take many forms – from the pilfering of supplies to selling confidential company information, check fraud and embezzlement through a company’s payroll system ranks among the most common.

The recession and the nature of many small businesses has created a perfect storm of sorts for a small percentage of employees that may be prone to theft:

Motive:

  • High unemployment has created more motive than ever before as spouses may be out of work and home foreclosures increase weekly.
  • With businesses in survival mode, employees may be working harder than ever without raises or bonuses, and feel “entitled” to a little extra from the company kitty.

Opportunity:

  • Small business owners typically run their firms with a family atmosphere, and trust their employees to the extent that proper policies to prevent theft are not in place. 
  • Small business owners, working so hard to stay afloat, may not see the warning signs associated with fraud. 

We’re not talking small amounts here.  The Association of Certified Fraud Examiners reports the average case of fraud at a small business creates a $127,500 loss. 

Payroll fraud can be perpetrated in several different ways, including:

  • Fictitious employees who draw a paycheck.  Typically, someone with access to payroll has created this fake worker, and has arranged for the checks to be cashed.  Similar thefts include unauthorized pay raises, bonuses, or commission checks.
  • Padded hours. Employees who may have had their hours cut back simply record additional hours to bump their paycheck up a notch. 
  • False workers’ compensation claims. It’s not a victimless crime.  Fake claims cause workers’ compensation insurance rates to increase, and create staffing issues.  We’ve all heard the tales of a worker faking an injury to draw a paycheck while working another job. 
  • Forged payroll checks. Fraudsters with access to company checks – whether they are hard copy or printable through a company computer –reproduce checks and write themselves an extra payday.  These devious employees will typically strike during a company’s busy period when the owner is less likely to have the time to closely review the books.

The bottom line is that to protect the bottom line, small business owners should review payroll policies and procedures.  Some tips for moving forward:

  • Outsource the payroll function. While outsourcing doesn’t automatically protect your company from payroll fraud, a business owner will no longer be buried in the details of working on payroll – and can use the extra time to better review payroll reports.  An outside payroll processing firm should also be able to create customized reports that allow a business owner to identify questionable figures.
  • Work with a CPA firm and/or other payroll professional to review your internal controls.
  • As simple as it sounds, set aside a specific amount of time each week to review payroll.  It’s not just for fraud prevention, but is a good management exercise as well.
  • Look for red flags, like an increase in the amount of checks which have been presented for payment, or an employee who insists of performing payroll functions single-handedly.
  • Split up payroll and bookkeeping duties among employees. Employees entering payroll data should not be reviewing their own work or distributing paychecks. Those in charge recording cash or payments should not perform the bank reconciliations.  
  • Reconcile the payroll journal regularly.  Unreconciled payroll data is perhaps the biggest invitation to theft.
  • Direct payroll deposit and debit systems are convenient for employees, but also create a greater need for payroll controls.

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