Fraud Risks: 6 Operational Functions Manufacturers Should Review

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Businesses must have internal controls in place in the event that employee theft arises. Generally speaking, there are only a few operational areas within a manufacturing and distribution (M&D) company where employee dishonesty involves the theft of money. These hot spots – cash and payment operations, accounts payable, payroll and purchasing – are key areas of focus in the theft prevention process. The dangers of theft can occur when an employee covers a sensitive job – compounded when one or two trusted employees have administrative access and password or financial report control to manipulate the accounting system.

The plan to prevent employee dishonesty rests on an effective internal control system, which must be uniquely tailored to your business. The following six areas deserve special attention when planning a system to prevent employee dishonesty and theft:

1. Inventory Manipulation

Inventory is the most vulnerable asset for fraud in the M&D industry. It contains a variety of SKUs, can be obscured with empty boxes and disguised with complicated accounting manipulations. In addition, it can be difficult to “count” raw materials. Management should suspect a problem when cost of goods sold is out of control, when there are numerous stock shortages and a higher than needed order rate. While periodic inventories are a useful tool, they are often staffed by the same employees who are in the best position to perpetuate a fraud.

2. Accounts Payable

Ghost vendors are a common problem. A clerk with control over both the creation of a vendor in the payables file and the payment of invoices can easily create a vendor, receive fake invoices for common goods or services, approve the invoice, and pay the bill. Checks can be sent to the employee’s address or saved for special handling and pick up. Often, each invoice is for a small amount, but over time, the total amount stolen can be substantial. Accounts payable personnel in cooperation with receiving and shop employees can work together to mask such a plan over many years. Vendor master lists are rarely reviewed independently, and inactive vendors are not properly closed if there has been no activity for six months to a year. These inactive vendors are an easy target for the fraudster.

3. Payroll

Ghost employees are also a challenge in the M&D industry. A clerk, with the ability to establish an employee, pay regular payroll and make changes to the master file, can easily create a false employee, increase amounts or fail to terminate an employee. Checks can be sent to an address or held for special handling and pick up. Once a false employee is created, benefits can also be funneled to the entity. Payroll registers are rarely reconciled between pay periods by an independent person or reviewed against a simple list of verified employees.

4. Check Tampering

M&D company owners sometimes pay their bills on the same day each week, mailing them in window envelopes complete with the company logo. If these are mailed at a post office, criminals will expect you at a certain day and time and wait to pick up these envelopes from the drop box. A check can be retrieved, altered and cashed, and the criminal now has the template to cash many more.

5. False Reimbursements

A good employee reimbursement system should include prior approval for large expenditures and enforcement of submission of receipts as proof of purchase. Generally, expense reimbursement forms are treated as a clerical nuisance and are rarely reviewed with appropriate care. The extra pay that some employees receive as a result of lazy review can be substantial.

6. Vulnerable Computer System

Many software systems have inadequate security to keep out cyber intruders. It is a big business to enter a system for identity theft, but more importantly, to steal contracts and valuable intellectual property. Devices can be embedded in the system that go undetected for many months, and sensitive information can be extracted without the knowledge of the system operator.

Mitigate Your Risk

While fraud cannot be prevented completely, the risk can be easily mitigated by:

  • Holding regular employee training on fraud prevention
  • Implementing an anonymous whistleblower system
  • Devoting time to mapping the current system and identifying the places where fraud would most likely occur
  • Performing a few simple tests to see if fraud is occurring and redesigning the control system to close these gaps

Additional ways to combat fraud include:

  • Sensitive duties should be separated among employees
  • A system of surprise internal audits and reviews should be implemented
  • Employees should be cross trained and rotated among jobs
  • Technology must be as secure as can be afforded

As a manufacturing business owner, it pays to be aware of the risks of employee theft. There may be no reason for concern at any point in your career; however, preventative internal controls are important to instill. To talk to our forensic and fraud experts, please contact us below:

This publication contains general information only and Sikich is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or any other professional advice or services. This publication is not a substitute for such professional advice or services, nor should you use it as a basis for any decision, action or omission that may affect you or your business. Before making any decision, taking any action or omitting an action that may affect you or your business, you should consult a qualified professional advisor. In addition, this publication may contain certain content generated by an artificial intelligence (AI) language model. You acknowledge that Sikich shall not be responsible for any loss sustained by you or any person who relies on this publication.

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