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Internal fraud: Identifying the risks and how to prevent

December 2021

How to spot internal fruad

If there’s one thing all business owners fear, it’s fraud. Whether in the form of theft, asset misuse, or data violation, fraud can be incredibly damaging from both a commercial and personal perspective – and more so if it’s inflicted by internal parties.

The sad reality is internal fraud – meaning criminal acts carried out by employees or those associated with the business – is surprisingly common. In 2019, 38% of UK businesses were hit by internal fraud, with cases ranging from data theft and leaks to reputational damage and adversarial social media activity.

Such is the threat of internal fraud, businesses are encouraged to make it a priority point for their broader security strategy. But what steps can you feasibly take to prevent internal fraud? And how do you identify the risks?

In this guide, we’re exploring internal fraud in depth, with practical tips on spotting the signs and taking action to prevent it.

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What is internal fraud and why is it so damaging?

Internal fraud is any criminal act committed by an employee or someone associated with a business. It’s among the most damaging types of fraud businesses face since employees can exploit their position within a company to commit acts of theft and embezzlement, often going undetected for long periods of time.

The issue of internal fraud is compounded by the fact that it’s hard to recognise, and even more difficult to come to terms with. Business owners place a lot of trust in their people, so cases of internal fraud naturally hit closer to home.

What’s more, internal fraud takes many forms and isn’t solely limited to theft. This makes it a triple threat, and one capable of causing a great deal of harm to a business’s long-term health and continuity.

Recognising internal fraud: Three fraud types explained

While internal fraud takes many guises, cases can generally be split into three categories: embezzlement, fraudulent payments, and data violations. Let’s take a closer look at each to understand their risks, impact, and signs to look out for.

Embezzlement

Embezzlement is when an employee or someone connected to a business steals money. It’s not as simple as straight theft, however, since there are means of hiding it which can make it difficult to detect.

If an employee was silly enough to steal from their place of work when cash has already entered the books, this is akin to basic theft and is generally easy to detect. That’s because the amount registered won’t correspond to what’s physically there, so you immediately know that something isn’t right.

If, however, they steal money before it’s entered the business’ cash flow, this is a different problem altogether. Known as ‘skimming’, this type of fraud is hard to detect since there’s no record of money having ever entered the business. Therefore, an employee could continue to ‘skim’ off the top for long periods unnoticed, with the potential for huge losses to the business.

Say, for example, an employee was to make a sale, receive money from a customer, but keep it for themselves rather than registering it in the system. This is one of the most common methods of skimming, and its impact can be sizeable if it goes unnoticed for long periods, or if there is more than one employee in on the act.

Fraudulent payments

Fraudulent payments fraud is when an employee or business partner sets up a payment to themselves or a third party. Typically, this type of fraud takes three forms, including invoice fraud, wage fraud, and expenses fraud.

  • Invoice fraud – when an employee sets up fake invoices to pay themselves or a third party from the company’s accounts.
  • Wage fraud – when an employee creates ‘ghost employees’ on a company’s payroll, listing them as offering ‘third-party services’, when in reality they’re fake and the employee is able to access the monies paid.
  • Expenses fraud – when an employee manipulates expenses documents, forging declarations and signatures to receive reimbursement for fabricated expenses requests.

As you might expect, fraudulent payments are difficult to detect since they’re often cleverly engineered and buried in genuine payment and invoice requests. As such, this illustrates the importance of regular accounts auditing and tight fiscal control.

Data violations and reputational damage

Data has risen to become one of the most valuable assets a business can hold, and would-be fraudsters are aware of this. Cases of data theft and violations committed by internal staff have increased hugely in recent years, as perpetrators look to steal sensitive company assets to either sell on or use as leverage in a bribery scenario.

And it doesn’t end there. Not only is data theft a growing problem, but businesses face the risk of severe reputational damage when their data and assets are improperly used by current or outgoing employees.

Because while data mismanagement may not sound like typical fraud, it can be categorised as such if an employee uses information to inflict reputational (and commercial) damage on a business.

As with fraudulent payments, this type of fraud is difficult to detect, and there are very few precursors to let you know that something is amiss. That said, prevention can be simpler than with other forms of internal fraud, with tight access controls and regular monitoring making it difficult for employees to misuse company assets.

Top tips for preventing internal fraud

While there’s no silver-bullet solution for stopping internal fraud, there are means of preventing it and lessening its potential impact. Below, we offer some essential practical tips on how to reduce the risk of internal fraud within your organisation.

  • Silo accounting duties – it’s rarely a good idea to leave one person in charge of your business’ accounting. Instead, split management between two or more parties to improve accountability and make things more difficult for would-be fraudsters.
  • Consider access controls – who has access to what within your organisation? Chances are, your teams only need access to one or two programmes, and not a full suite of systems and data sets. Assign access privileges with care and due diligence and make a note of who controls what.
  • Regularly audit your accounts – regular accounts auditing is one of the most effective ways to spot anomalies that could signal fraud is taking place. Monthly or bi-monthly accounts auditing is recommended to prevent long-term embezzlement.
  • Keep tight control of your inventory – remember: skimming makes it hard to detect embezzlement on the accounts side, so tight inventory management is needed to monitor stock level and ensure it corresponds with registered incomings. If you’re down on stock without the profit to show for it, something is amiss.
  • Vet your employees – the sad reality is, business owners need to vet all prospective employees to reduce the risk of falling victim to internal fraud. That means always following through on references, conducting background checks, checking them out on social media and LinkedIn, and holding face-to-face interviews to get the measure of them before they enter your company payroll.

Internal fraud may be on the increase, but with the right management and approach, you can reduce the likelihood of your business falling prey to unscrupulous individuals. For more business management tips and advice, click here to explore the full Perivan blog. To hear about our professional marketing and shareholder communication services, visit the homepage or contact our experts today.