Why you should be performing due diligence within your own business

Optimum Finance CEO Richard Pepler warns of the perils of internal financial fraud and why some internal naval gazing and spot checks are vital to ensure the long-term health of your business.

Most businesses are careful in carrying out due diligence checks before signing a deal with a new client. However, financial problems can as readily be caused by dishonesty or professional negligence from within a business.

You can never truly know whether someone is trustworthy and good at their job until you have worked with them for a significant period.

I will take you through the main types of employee fraud and offer some sage advice on sensible steps you can take to both prevent and detect any inappropriate or, worse, illegal conduct. These checks will also help uncover unintentional mistakes which could lead to financial problems further down the road. At best finding issues out after they have taken place can cause distraction and disruption to and at worst can result in client loss and irreparable damage to company or brand reputation.

Asset misappropriation 

This involves employees abusing their position to steal from an organisation through fraudulent activity. 

Prevention steps: 

1) Conduct thorough background checks on new employees using an external agency.

2) Implement checks and balances.

3) Separate the functions of cheque preparer and cheque signer.

4) Keep an eye out for any obvious ‘red flags’ from employees such as:

• • A lavish lifestyle that doesn’t match their salary
  • Not taking vacation or routinely staying late/working on weekends
  • Frequent comments or complaints about an employee
  • Inventory shortages
  • An employee who is reluctant to share his/her job function

 Vendor fraud

This is a method of asset misappropriation that uses an organisation’s payment activities to suppliers to direct funds into an employee’s pocket. 

Prevention steps: 

1) Conduct due diligence on all third parties.

2) Conduct due diligence when setting up vendors and random audits of vendor files.

3) Compare vendor addresses with employee addresses.

5) Implement a dual review process for master vendor file management.

6) Review the vendor master file to check that volume of billing is reasonable and consistent.

7) Don’t pay commission until goods and services have been delivered.

Accounting fraud 

This is the intentional misrepresentation or alteration of a business’s accounting records regarding sales, revenues, expenses and other factors. 

Prevention steps:

1) Rotate duties of employees in accounts payable and accounts receivable.

2) Conduct random audits of company accounts.

3) Implement tight internal controls on accounting functions.

4) Separate the functions of account setup and approval.

5) Conduct random audits of accounts payable and accounts receivable records.

6) Assign a trusted outside contractor to review and reconcile accounts at regular intervals.

Payroll fraud 

This is when employees cheat the payroll system to gain payment which they are not owed. 

Prevention steps:

 

1) Reconcile balance sheets and payroll accounts each month/quarter.

2) Require managers or supervisors to approve time sheets and overtime claims.

3) Institute mandatory vacations for payroll employees.

4) Restrict payroll department employees’ ability to modify pay rates and hours.

5) Perform data analytics on payroll records.

6) Check payroll records to ensure terminated employees have been removed from the payroll.

7) Separate tasks of preparing payroll checks and reconciling payroll account.

Data theft 

This is the illegal use or sharing of confidential data by an employee, usually for their own personal gain. This can often occur when an employee is looking to leave their role so it’s vital to ensure robust measures are in place.

Prevention steps: 

1) Restrict access to company proprietary information.

2) Set up IT controls to alert management of large data downloads/transfers or downloads/transfers that occur at odd times.

3) Purchase software that alerts management of suspicious activity on a company network.

4) Dispose of confidential information properly.

5) Use strong passwords for all computers/devices.

6) Implement a clean-desk policy that prohibits employees from keeping sensitive information on their desks while they are not present.

Generally, ensuring your business has a strong code of ethics and that everyone in the company, from the top down, knows and puts it into practice will keep things in order.

Financial fraud and impropriety can be found in any size business so SME owners should not think that it won’t happen to them. While no one wants to work in a police state style business culture ensuring these measures and checks are in place promotes an environment which is positive, transparent and equitable.