Business fraud in South Africa is on the rise; it’s crucial to spot red flags of fraud to protect your business. If you think fraud can’t affect your business, think again. Recent statistics reveal a staggering 30% increase in business fraud over 2024. The most worrying part is that 41% of these crimes were committed by internal employees.
Businesses across the board are trying to find ways to tackle fraud, but it’s important to first know what the red flags of fraud are so that you can start to protect your business and fight this crime from the inside.
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Types of business fraud & white-collar crime
At its core, business fraud is any deceptive activity by an individual or entity to achieve an unfair or unlawful gain at the expense of a business. Understanding the different types is the first step in identifying red flags of fraud within your own business.
Some of the most prevalent types of fraud and white-collar crime include:
- Asset misappropriation: This involves the theft or misuse of a company’s assets and can range from skimming cash and fraudulent disbursements (e.g., false invoices, payroll fraud) to stealing inventory or company equipment.
- Corruption: This is when a person abuses their position of trust for personal gain. Examples include:
- Bribery: Offering, giving, receiving, or soliciting anything of value to influence a business decision.
- Kickbacks: An illicit payment made in return for a favour or service.
- Conflicts of interest: When an individual’s personal interests (or those of their close associates) conflict with the interests of the business, leading to biased decision-making.
- Financial statement fraud: Often the most damaging type of fraud, it involves the intentional misrepresentation of a company’s financial records to deceive investors, creditors, or other stakeholders.
- Cybercrime and data fraud: This includes activities like phishing scams, ransomware attacks, identity theft, and the unauthorised access or manipulation of sensitive company data.
- Vendor fraud: This happens when a vendor defrauds a business, often through inflated invoices, duplicate billing, or the delivery of substandard goods or services.
Five red flags of fraud to look out for
While every business is unique, there are common red flags of fraud that, when observed, should cause concern and definitely warrant a closer look at what’s really going on.
1. Unexplained or irregular financial anomalies
One of the most obvious red flags of fraud and often the first sign that something is wrong. You should be looking for:
- Sudden or unexplained drops in revenue or increases in expenses: Is there a logical business reason for these shifts, or do they seem out of sync with market conditions or operational changes?
- Discrepancies between physical inventory and accounting records: This can be a sign of theft or mishandling of goods.
- Unusual fluctuations in profit margins: If your profit margins are unexpectedly volatile, it could indicate manipulated figures.
- Multiple payments to the same vendor within a short period, especially for round-sum amounts: This could suggest duplicate billing or fictitious vendors.
- Missing or altered financial documents: Any attempt to conceal or destroy records is a huge red flag.
- High volume of credit memo activity: This could be a way to cover up cash skimming.
What you should be doing: Implement stronger internal controls, including regular recons of accounts, thorough expense reviews, and regular independent audits. Pay close attention to trends and deviations from expected norms. Question anything that doesn’t add up or seems out of place.
2. A change in the behaviour of employees
While you obviously shouldn’t jump to conclusions, unexplained changes in an employee’s lifestyle or behaviour can be a red flag of fraud. You should be looking for:
- Sudden affluence that doesn’t align with their salary: This could include lavish purchases, expensive holidays, or a rapid upgrade in living standards.
- Unwillingness to take holidays or delegate tasks: Fraudsters are often worried that their illicit activities will be discovered if someone else steps into their role.
- Excessive control over certain processes or reluctance to share information: If an employee insists on being the sole point of contact for a particular task or seems to guard information closely, it could be to prevent others from uncovering their fraud.
- Changes in personality or increased stress levels: While life events can cause these, a sudden shift in behaviour, especially combined with other red flags, could be a sign of guilt or fear of being caught out.
- Close relationships with vendors or customers that seem overly personal: This could indicate kickbacks or conflicts of interest.
What you should be doing: Build a culture of transparency and open communication. Encourage employees to take annual leave and ensure cross-training for critical roles. Take note of changes in an employee’s financial situation or behaviour, especially if they are in a position of trust.
3. Weak internal controls and lack of sharing duties
The absence of proper checks and balances, along with resistance to sharing duties, are major red flags of fraud. You should be looking for:
- Resistance to sharing duties: If one person has control over an entire transaction from initiation to completion (e.g., ordering, receiving, and paying for goods), it creates an opportunity for fraud.
- Lack of regular reconciliation processes: Without regular checks between different records (e.g., bank statements and company ledgers), errors and fraudulent activities can go undetected.
- Poor oversight of financial transactions: Are invoices approved without proper verification? Are expense claims scrutinised effectively?
- Inadequate documentation of transactions: If there’s a lack of clear audit trails, it becomes difficult to trace transactions and identify fraudulent ones.
What you should be doing: Implement and regularly review strong internal controls. Ensure that no single employee has complete control over a process. Mandate regular reconciliations, detailed documentation, and periodic internal and external audits. Establish a clear and accessible channel for employees to report concerns.
4. Unusually close vendor and customer relationships
While good relationships are key to good business, overly close or secretive relationships between employees and external parties are one of the red flags of fraud. You should be looking for:
- Employees receiving lavish gifts, dinners or holidays from vendors/customers: This could be a form of bribery or a kickback.
- Unjustified sole-sourcing of contracts to a particular vendor: Is there a legitimate reason for not seeking multiple bids, or is there an undisclosed relationship at play?
- Vendor invoices with vague descriptions or unusually high prices: This could indicate inflated billing or phantom vendors.
- Unexplained rush orders or preferential treatment for certain customers/vendors: This might suggest a conflict of interest or an attempt to circumvent standard procedures.
- A sudden increase in business with a new, unknown vendor: Is there a legitimate reason for the new relationship, and has due diligence been performed?
What you should be doing: Implement a clear gift and hospitality policy. Enforce competitive bidding for significant contracts. Conduct thorough due diligence on new vendors and customers. Encourage employees to disclose any potential conflicts of interest.
5. High turnover in key financial roles
High employee turnover in sensitive positions can often be subtle red flags of fraud. You should be looking for:
- High turnover rates in accounting, finance, or procurement departments: This can make it difficult to maintain institutional knowledge and can be a sign that something is wrong within the department. It also creates opportunities for new fraudsters to enter.
- Lack of adequate training or resources for employees in critical roles: This can lead to errors that might be mistaken for fraud or, worse, create opportunities for deliberate misconduct.
What you should be doing: Monitor employee morale and retention rates, particularly in sensitive departments. Implement background checks for new hires in financial positions.
Beyond the red flags of fraud
Spotting the red flags of fraud is crucial to protect your business, but prevention is always better than cure. At Loxton Forensics, we advocate for a proactive approach to fraud management. This includes:
- Developing a strong anti-fraud culture that starts from the top. Ensure that management sets the tone for ethical behaviour and zero tolerance.
- Regularly identify and assess your business’s vulnerabilities to fraud.
- Document all financial processes and ensure employees are aware of their responsibilities and the consequences of fraudulent behaviour.
- Educate your team on what fraud looks like, how to report it, and the importance of behaving ethically.
- Use data analytics and other tools to help identify suspicious patterns that might be fraudulent activity.
- Know how you will react if fraud is suspected or detected.
Business fraud is a persistent threat, but by understanding its forms and actively looking for the red flags of fraud, you can build up your business’s resilience.
Early detection and decisive action are your best weapons in the fight against fraud.
Contact us today to help you protect your business, empower your employees, and build trust and integrity across your business.