From time time DDIFO is pleased to present Guest Commentary from valued contributors. The following is an article about Fraud Detection written and submitted by Steven Schottenfeld of  TraceTech Solutions , 7 Josephine Street, Canton, MA 02021, 339-237-1696,
Steven will be attending the DDIFO Members Meeting on March 4th and conducting a Workshop titled: “Best Practices in Preventing and Detecting Fraud” it will start at 3:00 PM.

Steve Schottenfeld, of TraceTech Solutions

In January, 2010, a Michigan man was sentenced to one year in prison after he and his wife (a bookkeeper for a McDonald’s franchise owner) admitted to stealing $441,672.75 from the business. Over a nine-month period she wrote 42 unauthorized checks to herself and her husband.

As a franchisee it’s not hard to imagine that “this could have been you”.  Fraud is a fact of business life, and if you’re not paying much attention to it your business could be losing tens or hundreds of thousands of dollars every year.  This article will discuss several aspects of small-business fraud: the extent of the problem, some “red flags” that may indicate that someone is stealing your money, techniques that you can use to prevent many common small-business frauds and how to go about detecting an on-going theft.

Small-Business Fraud

Most likely you’ve probably been in business for a while and you’ve read or heard all the fraud stories.  But as far as you’re concerned your organization has fraud under control, right?  That’s what every owner/operator thinks!  The statistics tell a completely different story, though.

  • Across the U.S., the average small business loses 7% of its annual revenue to fraud.  The sad part is that since fraud is concealed theft, business owners have no idea that they’re being robbed.
  • The employees who are doing most of the stealing aren’t the ones behind the counter.  The most “dangerous” group of small-business fraudsters are, in fact, a business’ most trusted employees: its managers, supervisors, bookkeepers, accounting clerks, payroll and benefits coordinators, etc.
  • The average fraud scheme goes undetected for over two years.  That’s a long time – time enough for a fraudster to gamble away a lot of your money, take expensive vacations or pay off lots of personal debts.

Red Flags

Fraud is concealed theft, so there’s a good chance that if a fraudster is stealing your money you won’t notice it.  However, a few red flags may indicate that you’re being victimized.  Keep an eye out for these signs:

  1. Unexpected and/or unexplained cash flow problems. You should have a good handle on your cash flow.  If something just doesn’t seem right it just might be because an employee is embezzling your cash.
  2. Employees living beyond their means
    Employees who live it up in style may have a legitimate way of supporting that style.  But then again, the money may be coming from you – and not in the form of a paycheck, either!
  3. Employees who don’t take vacations

Fraudsters often leave “traces” of their theft in the business’ records such as its books, bank statements, payroll files and vendor files.  Many fraudsters shun vacations to prevent other employees from finding those traces.  So while you may applaud the devoted employee who never takes a vacation, you should also be aware that they could be trying to hide something.

Note that the existence of a red flag in your organization doesn’t necessarily imply that you’re being victimized, any more than the absence of red flags indicates that you’re not being victimized.  Red flags, however, should raise your fraud alert level.  We’ll discuss what that means shortly.

Reducing Your Fraud Risk

There are two ways to reduce your fraud risk: taking fraud prevention measures and taking fraud detection measures.  There’s no such thing as “one-stop shopping” here.  Different measures will target different fraud schemes.  For example, the following three types of small business fraud schemes can result in some of the largest losses:

  • check tampering schemes
  • fraudulent invoicing schemes
  • payroll fraud schemes

So the measures that you take should be directed at these schemes.  In the rest of this article we’ll suggest small measures that you can take to prevent and/or detect some popular variations of these schemes.  But the list is only a start.

Check-Tampering Prevention and Detection Measures

Check tampering schemes are the most popular small-business type of fraud scheme.  Check tampering occurs when an employee either prepares a fraudulent check for their own benefit or converts a check intended for someone else into one they can control.  The example in the first paragraph of this article is a very popular variation: the employee simply writes checks to themselves (or “Cash”, or a relative, or an accomplice, etc.).  You might wonder “how can they get away with that”?  Well, it’s instructive to consider how they conceal such a theft, often for many years:

  1. they usually forge the signature, so the owner  never sees the check
  2. they typically enter the check into the books as being paid to another party such as a legitimate vendor.  To someone looking at the books or reports, the entry seems to be perfectly normal.

Now that you have some background, you’ll see why the following measures can prevent and/or detect many common check-tampering schemes:

  1.  If your organization has two or more employees in the accounting department, the employee responsible for reconciling the monthly bank statement should not have the authority to write checks
  2. Have monthly bank statements delivered unopened to you.  When you receive a bank statement examine the payee on every cashed check and every electronic disbursement.  Investigate “unusual” payees.

Simply following these two procedures will cost you about fifteen minutes per month.  But they could save your business thousands of dollars.

Fraudulent-Invoicing Prevention and Detection Measures

A manager for an Illinois manufacturer recently pleaded guilty to setting up two bogus companies and invoicing his employer for services that were never rendered.  By the time the scheme was uncovered, the manager had stolen $1,500,000 from the company.

Shell company schemes are very popular because everything looks legitimate from all angles: invoices look legitimate (even though they were printed on the employee’s home computer) and real payments were made against those phony invoices.  But here are some simple measures that can prevent and detect many fraudulent invoicing schemes:

  1. If your organization has two or more employees in the accounting department, the employee responsible for entering new vendors into the accounting database should not have invoice-approval authority
  2.  Prior to entering a new vendor into the database, your bookkeeper should call the vendor to make certain that the vendor exists
    Neither major measure will likely place a big time burden on either you or your staff.

Payroll Fraud Prevention and Detection Measures

A benefits and payroll coordinator for a Sudbury, MA garden center was recently found guilty of putting two “ghost” employees on payroll and collecting their pay  After five years she had stolen $290,000 from the company.

The popularity of payroll fraud schemes is surprising.  Payroll frauds are easily-detected because the evidence is so obvious – it just needs to be looked at!  Here are two simple measures that can detect many common payroll fraud schemes:

  1. Have your business’ payroll reports reviewed regularly – by someone other than the one who entered the payroll data!
  2. Take a few minutes to examine each year-end payroll report.  Specifically look for:
    a. employees whose compensation is out of line with your expectations — including terminated employees!
    b. employees that you don’t know
    c. employees with little or no withholding or tax deductions


Fraud should not be taken lightly.  Many small business owners have unknowingly been taken for a lot of money, and many never recovered from the loss.  Because business owners can’t “see” fraud, they underestimate their risk and consider fraud losses to be a cost of doing business.  It doesn’t have to be that way.  Owners can take many simple measures to reduce their fraud risk.  The sheer number and variety of schemes is enormous, so getting external help is normal.  For preventative measures, your accountant should be your primary source for fraud-reduction measures specific to your organization.  And on the detection side,  affordable fraud detection services that sniff out many common fraud schemes are now available.