The true cost of fraud

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Tracy L. Coenen

When we think of on-the-job fraud, we tend to think in extremes. One extreme is the teenage punk with orange hair and a nose ring, and he’s stealing cash out of the register or letting his friends have free chips and soda. The other extreme is that of the wealthy executive who runs off with millions by extracting lavish gifts and manipulating the company’s financial statements to boost the stock price and enhance his bonus.

The problem with these extremes is that they fail to consider the majority of thefts that go on within companies. Most occupational fraudsters steal between $10,000 and $500,000 from their employers. While these dollars can be significant to companies of varying sizes, they only represent the dollars directly taken by the employee.

A company’s cost of fraud goes far beyond the initial sums of money stolen by a dishonest employee. These costs range from some tangible negative effects, to other less tangible results throughout the company. One way or another, they all cost the company time, money, productivity, and potentially customer relationships.

The Direct Financial Impact

It is often easy to see the direct financial impact of an internal theft by adding up the numbers. But then again, that only includes the known theft. What about other inappropriate expenses or concealed thefts? Even with a thorough investigation, it may not be possible to find 100 percent of the theft.

The dollars stolen by a dishonest employee deeply affect the financial statements. The previously reported profits or losses of the company are likely affected, and the impact will naturally depend upon how the theft was recording in the accounting system.

The balances of the assets, liabilities, and equity will be affected as well. Certainly the cash flow of the company will be affected, since cash during the theft period was flowing to the fraudster when it should have been put into operations.

The loss of the cash can negatively affect many areas of the company. Some of the most commonly impacted areas of a company include material purchasing, payroll, and other vendor payments. Without money to pay for the materials and people that the company needs, its future can be in jeopardy.

Another area of the company sometimes affected by an internal theft is tax obligations. A fraudster may steal the money set aside for the payroll taxes, and this is especially prevalent in smaller business. Unpaid payroll taxes result in significant penalties to the business, and the tax debts multiply quickly.

While some of the financial losses may be covered by an insurance policy, the stolen funds are almost never fully recovered. It is a rare case in which the thief is able to repay what has been stolen. Even when funds are recovered, there are almost always additional costs related to the fraud which are not reimbursed.

It is easy to see how even the direct costs of fraud can mount quickly. It is easy for some to suggest that a thief is merely decreasing a company’s profits, and that doesn’t matter so much. But that’s not necessarily true, and many times a dishonest employee is stealing cash that is vital to the ongoing operations of the company.

The Indirect Financial Impact

As a company deals with the direct financial fallout from an internal theft, the fraud costs the company in many other ways. Upper management, whose leadership, sales ability, and business management expertise are often so sorely needed after a major theft, is often distracted. Management tries to put the pieces of the theft together while inadvertently ignoring the regular operations of the company.

As already mentioned, the prior financial statements of the company are now deemed unreliable. Since accurate financial statements are critical to many aspects of a business, the company must do the work necessary to correct them.

Money must be spent on investigating, restating the financial statements, and possibly re-issuing audit opinions. Fees must be paid for attorneys, auditors, accountants and investigators to help sort through the financial damage done by the thief.

Preservation of financing sources after a significant internal theft is critical, but sometimes difficult. Unreliable financial statements can cause a bank to reconsider its relationship with the company. Particularly when a company’s tax and other obligations mount because of a theft, it may be difficult to secure ongoing financing.

A company’s shareholders may also lose faith in the company and its management team after a significant fraud. The value of the company may go down and it may be difficult to attract new investors and new capital. At the very least, there will be time and effort spent reassuring investors that the company is still on solid financial footing.

Additional expenses may mount as the company brings in consultants to help secure assets and prevent future frauds. Fixed assets may be purchased as computer systems are made more secure and the physical security of the company’s premises is enhanced. New risks within the company may be discovered, and it will cost money to protect the company from these threats.

The Effect on Employees

One of the most disturbing effects of the discovery of an internal fraud is the devastation that employees feel. It is demoralizing and it costs companies money via decreased productivity and attrition.

It is not unusual for co-workers of thieves to feel violated. They were working alongside someone they trusted; someone who was lying for a period of time. The longer the fraud scheme went on, the more violation a co-worker may feel.

The anger and resentment often stems from the idea that the thief was taking something other employees weren’t getting. Had that employee not stolen from the company, all the other employees stood to gain via raises and increased benefits. Instead, part of the company’s profits went straight into the dishonest employee’s pockets.

If the fraud is large enough, it may even put the future of the company in jeopardy. The remaining employees reflect on what could have happened. They could have lost their jobs and their families may have suffered because of it.

Add to this the fact that the remaining employees may have additional job responsibilities to keep things running. The company has fewer employees to do the job. The remaining employees may be expected to participate in an ongoing investigation, and additional work may be created because of new controls aimed at preventing future frauds. Add it all up, and everyone is angry and overworked.

The negative energy in the office may cause decreased productivity, further hampering the company’s efforts at recovering from the fraud. Valuable employees may be lost because they can no longer work in such an environment, or they wish to have a new start somewhere else. The cost of replacing the good employees mounts quickly.

The Total Cost

Many of the costs associated with fr
aud might not be mitigated. Fees to help sort through the financial mess and re-issue financial statements may not be avoided. Financial statements that banks and investors can rely upon are necessary and must be produced in spite of the cost.

The tangible costs related to employee issues might be reduced with good management of the remaining workforce. The issues surrounding employee morale might not be managed so easily. These issues are so easily forgotten, yet so costly to the companies.

The total cost of fraud, both in terms of lost dollars and decreased productivity, is difficult to fully appreciate. Yet it is clear that the cost is high, and therefore the prevention of fraud is paramount to successful businesses.