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The Fraud Triangle – A Lesson in Accounting Geometry

Need – Opportunity – Rationalization

Do these words raise the hair on the back of your neck?  If you are a business owner, they should.  This is the fraud triangle – a tool to help identify potential problems in your company.  We are all so busy, and we trust the people we work with (otherwise we probably wouldn’t be working with them!), but don’t turn a blind eye to potential problems staring you in the face.

NEED – Well, everyone has needs.  But has an employee recently started to talk about gambling a lot?  Or that their spouse was laid off or someone in the family is ill?  There is nothing you can do about an employee’s need, but be aware that it is part of a decision to step over the line.  If an employee is not in a good space, sometimes a little care and empathy will keep the person on the up and up.

OPPORTUNITY – This is where we try to make sure we don’t leave uncounted cash laying around for the taking.  Of course we wouldn’t do that!  But if you aren’t checking into some financial details occasionally, you are leaving the barn door wide open.  The easiest thing to do as a small business owner is to grab the mail every once in a while and open everything.  Are there IRS or State correspondence letters indicating that taxes aren’t paid?  Are there vendors or credit card bills that you don’t recognize?  Follow through and match credit card receipts to the bills and invoices to the vendor if it’s not something you recognize readily.  Get the bank statement and review the electronic charges being paid automatically out of your account, and compare cash receipts to your perception of cash flow.

RATIONALIZATION – People like to be treated fairly.  If Joe gets perks for the same job that Bill is doing without the perks, there is a sense of unfairness, and a chance that Bill will rationalize padding his expense account ‘to make things even.’  Do you have policies that treat people unfairly?  Are you motivating employees to cover up errors or cheat because they need to meet sales goals or quotas for a bonus?  These could be legitimate policies with unintended consequences.  You yourself work very hard in your business, and you deserve some leeway in running personal expenses as business expenses, right?  Everyone does, right?  The four-wheeler could be used at the business, right?  Well, the receptionist that just had to deal with an upset customer that paid cash works hard too.  And if you told her there’s not enough money to give her a raise right before you bought that four wheeler, she has the perfect reason to rationalize that she deserves a small part of that cash.  Try to set the tone at the top that transparency and fairness are the order of the day, and it will be harder for someone to rationalize.

In short, don’t rationalize to yourself, keep yourself involved, and do surprise checks on the things that drive your business and the fraud triangle will diminish in size at your business.