How to Spot Early Signs of Employee Theft or Embezzlement
Employee theft and embezzlement are highly damaging forms of financial fraud — so damaging, in fact, that they can bring small businesses down.
Businesses lose an estimated 5% of revenue each year to occupational fraud, says the Association of Certified Fraud Examiners (ACFE). Small businesses are often the hardest hit, as they typically have fewer anti-fraud controls and may place a high level of trust in employees managing financial responsibilities.
Sadly, employee fraud doesn’t exactly announce itself with sirens and flashing lights. It sneaks in quietly and grows over time. And by the time it’s discovered, the damage may be substantial.
The good news? Many instances of employee theft and embezzlement leave clues — if you know what to look for. Here’s how to spot early red flags so you can act quickly to limit losses and protect your company.
Behavioral Red Flags: Warning Signs in Plain Sight
People who commit fraud don’t necessarily fit a mold, but certain behaviors tend to show up more frequently than others.
These red flags don’t prove guilt, but they can warrant a closer look, especially if they coincide with other warning signs:
- Reluctance to share duties: Employees who are unwilling to delegate tasks or take vacations might be trying to keep coworkers from discovering irregularities. A refusal to cross-train others or an insistence on controlling all aspects of financial processes can be a major red flag.
- Lifestyle changes that don’t add up: A sudden increase in spending — new cars, expensive vacations, luxury clothing — without a corresponding raise or promotion might suggest the person is getting money from somewhere else.
- Financial stress or gambling problems: Personal issues such as mounting debt, addiction or family pressure can sometimes motivate individuals to steal.
- Defensiveness or secretive behavior: Employees who become overly defensive when questioned about financials or who seem unusually secretive about routine transactions may be hiding something.
- Past history or complaints: A previous employer’s reference that was vague or overly positive for a short tenure, or a trail of HR complaints, can be worth revisiting if suspicions arise.
Again, we have to stress: They don’t prove guilt. For instance, a sudden increase in spending could very well be connected to a corresponding raise or promotion for your worker’s spouse, or even a windfall such as an inheritance. That’s why it’s important to view these as potential signs that might merit further investigation, but not necessarily evidence.
Suspicious Financial Patterns: Follow the Numbers
Behavioral cues are only part of the equation.
The more objective indicators come from your company’s financial records. Thus, regular reviews of internal data can help you detect:
- Unexplained discrepancies: Look for inconsistencies between bank statements and internal ledgers, or between purchase orders and actual deliveries. Even small, repeated variances can point to a larger issue.
- Fake invoices: If an employee has authority over both accounts payable and vendor relationships, they might create and pay fake vendors. Watch for recurring payments to unfamiliar vendors or those with incomplete contact details.
- Complaints about billing errors: If customers or vendors report being overbilled or notice inconsistencies in their invoices, that could indicate someone is manipulating receivables. Make sure vendor invoices align with existing contracts.
- Excessive or duplicate refunds: Refund abuse is another common scheme, especially in retail or service environments. Frequent refunds, especially processed manually or after hours, deserve scrutiny.
Processes That Can Prevent Fraud
Even the most trustworthy employee can be tempted if your business lacks basic controls. That’s why it’s important to have certain rules and structures in place.
Segregation of duties is particularly important. A single person should never control every step of a financial transaction. For instance, the person who writes the checks should not be the same person who reconciles the bank account.
In a similar vein, you want to have mandatory vacations and pair it with role rotation. Requiring employees to take time off and having others temporarily step in their roles can expose hidden fraud — indeed, long-running schemes are often discovered this way.
It’s a lot easier to commit fraud from behind a screen than it is in a building with other coworkers around, so you want to ensure your businesses has appropriate oversight of remote workers. Cloud-based financial systems and regular performance reviews are essential parts of this.
Lastly, make sure you’re conducting regular business audits. Scheduled audits are a smart accounting practice for numerous reasons and should be part of your strategy, but unannounced audits can be particularly helpful in identifying fraud.
How to Respond If You Suspect Fraud
If you think something’s not right, resist the urge to confront the employee immediately or conduct your own internal investigation. Mishandling a suspected fraud case can lead to destroyed evidence, legal complications, even wrongful termination suits.
Instead …
- Hire an attorney: You are almost certainly not a legal expert. Proper counsel will advise you on investigation options, whether that’s conducting one yourself or hiring an outside investigator. And again — mishandling potential fraud could rebound back on you and your company.
- Engage a professional: If advised by legal counsel, hire a forensic accountant or fraud examiner who can help you discreetly investigate and preserve evidence.
- Secure your financial systems: If advised by legal counsel, limit the suspect’s access to sensitive systems without alerting them to your suspicions.
- Document everything: Keep detailed records of your observations and any supporting documentation. Don’t rely on memory.
Worried About Financial Fraud in Your Business?
Even the most diligent business owners can’t be everywhere at once. If you suspect fraud or simply want to strengthen your internal financial controls, a trusted advisor can help.
McManamon & Co. is an accounting, tax, fraud, forensic and consulting firm that serves small and midsize businesses. If you’re facing a fraud or corruption situation, we can work with your legal counsel and help you determine what happened, how much is at risk, and who’s involved and identify recovery opportunities.
Call us at 440.892.8900 or contact us today to learn how we can help protect your business from within.
Tags: audit, fraud, McManamon, McManamon & Co., small business, small business fraud | Posted in Fraud