You want to trust your employees, and most of the time, that trust is well-placed. But trust alone won’t protect your business from internal fraud. Employees who commit fraud often understand financial processes and take small amounts over time to avoid detection. Without strong oversight, even well-run companies and nonprofits can become victims of internal fraud.
This article explains how internal fraud happens, essential warning signs to watch for, and practical steps to protect your business.
What Are Common Types Of Internal Fraud?
Several areas of your business are at risk for internal fraud, so understanding the most common types can help you take action before large losses occur. Here are common ways employees commit fraud:
- Payroll fraud. Employees manipulate payroll to inflate their pay, submit fake overtime, or create ghost employees and direct salaries to themselves or accomplices.
- Check and payment fraud. Altering check amounts, processing duplicate payments, or forging signatures for unauthorized transactions.
- Expense reimbursement fraud. Submitting fake receipts or inflating expenses for larger reimbursements.
- Embezzlement of cash or inventory. Skimming cash before it's recorded, diverting funds through manipulated accounting records, or making unauthorized transactions.
- Financial statement manipulation. Altering financial reports to hide losses or overstate revenue.
- Fake invoices and vendor kickbacks. Creating fake vendors, overpaying in exchange for kickbacks, or approving payments for personal expenses disguised as business costs.
- Data theft and intellectual property fraud. Stealing client lists, trade secrets, or proprietary data for personal gain.
- Discount or refund abuse. Granting unauthorized discounts or refunds to friends, family, or personal accounts.
Many cases of internal fraud share a common factor: lack of oversight. When one employee controls multiple financial steps, such as creating vendors, approving payments, and reconciling accounts, it’s easier for them to commit fraud and much harder to detect.
What Behaviors Are Suspicious For Internal Fraud?
Catching internal fraud early can prevent significant financial loss. While no single behavior confirms fraud, these behavioral patterns can be red flags:
- Avoiding vacation. Employees who refuse time off or insist on handling all financial tasks themselves may be hiding fraud.
- Working unusual hours. Employees who consistently work when others aren't present, particularly handling financial tasks during off-hours without clear business justification, may be looking for opportunities to work without oversight.
- Resisting procedure changes. Employees who strongly oppose new financial controls, technology updates, or audit procedures might be protecting vulnerabilities they're exploiting.
- Unexplained wealth. Sudden lifestyle upgrades, such as luxury cars, vacations, or expensive purchases, without a clear source of increased income.
- Financial pressure. Employees frequently discuss financial struggles or show signs of money-related stress.
- Gatekeeping information. Employees who insist on exclusive access to accounts, resist oversight, or refuse to share key financial data.
How Can You Identify Internal Fraud?
Unexplained financial irregularities often provide the most solid evidence of internal fraud. Depending on how they committed it, you might spot:
Suspicious payments. Duplicate payments appearing in your records, especially to vendors with similar names or addresses. - Reconciliation discrepancies. Reconciliation reports that don't match up with actual cash flow or bank statements.
- Pre-audit adjustments. Irregular timing of financial record updates, particularly last-minute changes before audits or reviews.
How Can Businesses Prevent Internal Fraud?
Preventing internal fraud requires structured oversight, controls, and a culture of accountability. A strong fraud prevention strategy includes clear financial processes, active monitoring, and an engaged team that understands its role in protecting the business.
Implement Strong Internal Controls
Business owners should have their own unique banking login credentials to regularly review financial transactions directly. This is one responsibility that can't be delegated entirely. Your direct oversight demonstrates accountability at every level of your organization.
Equally important is distributing financial responsibilities among multiple employees. When no single employee controls entire processes from start to finish, the opportunity for internal fraud drastically decreases. Require dual approval for high-risk transactions like wire transfers or large payments so two authorized employees must sign off.
Regularly Review Financial Activity
Even with strong controls, ongoing financial oversight is essential to detecting fraud before it escalates. Key strategies include:
- Surprise spot checks on high-risk transactions and financial records.
- External audits by independent accounting professionals.
- Routine expense report reviews to maintain compliance with company policies.
These reviews can catch irregularities earlier and reinforce consistent oversight, discouraging employees from attempting fraud.
Build A Culture That Discourages Internal Fraud
A workplace where employees feel valued and accountable is less vulnerable to internal fraud or embezzlement. Here are a few ideas to help you build a strong culture that discourages it.
Start a whistleblower program. An effective program encourages employees to report their concerns confidentially without worrying about retaliation. Internal fraud often is discovered through tips from observant employees. - Provide regular fraud awareness training. Employees should learn how to recognize red flags and understand the consequences of internal fraud on everyone in the organization.
- Clearly communicate financial policies. Provide training to ensure that all employees follow procedures on approvals, reimbursements, and internal controls so that any financial irregularities stand out.
No single measure eliminates all fraud risk, but a layered approach can reduce your risk of internal fraud and demonstrate that your leadership takes financial integrity seriously.
Which Fraud Prevention Solutions Help Prevent Internal Fraud?
Beyond internal controls, fraud prevention solutions available through your bank provide an extra layer of protection against internal fraud by preventing unauthorized transactions before they happen.
Positive Pay
Positive Pay helps prevent internal fraud by flagging altered or unauthorized checks before they clear. Businesses submit a list of approved checks, and any mismatches trigger an alert for review, helping to block fraud before funds are lost. Dual control in combination with Positive Pay is essential to ensure complete protection against check fraud schemes. This two-layered approach requires at least two employees to initiate and approve check payments, eliminating single points of vulnerability where one employee could create and authorize fraudulent transactions. Positive Pay can help you:
- Prevent altered checks. Employee attempts to change the payee name or check amount are thwarted by Positive Pay as discrepancies are flagged before processing.
- Supports detection of unauthorized checks. When combined with proper dual control procedures, the system helps identify checks that weren't properly authorized through established approval workflows.
- Identifies duplicate payments. Positive Pay ensures that checks aren’t fraudulently duplicated and cashed multiple times.
Lockbox Services
With lockbox services, your customers send payments directly to a secure processing center, providing many benefits, like reducing the risk of check tampering and streamlining faster payment processing. Read more about the benefits of lockbox services. Lockbox services helps you:
- Stop fraudulent diversions. Employees never physically handle payments, reducing the risk of internal fraud by redirecting or altering payments.
- Get paid faster. Payments are processed and deposited quicker, improving cash flow by decreasing internal handling time.
- Ensure deposit accuracy. Secure processing prevents employees from altering payment amounts or misapplying funds for personal benefit.
ACH Positive Pay
ACH Positive Pay helps prevent internal fraud by stopping unauthorized electronic withdrawals before they happen. This tool ensures that only pre-approved vendors can debit your account(s), automatically blocking fraudulent or unexpected transactions. ACH Positive Pay allows you to:
- Prevent unauthorized withdrawals. Block any ACH transaction from vendors or individuals who are not on your approved list.
- Stop fraudulent employee payments. Prevent employees from setting up personal accounts or fake vendors to withdraw company funds.
- Protect against internal errors. Avoid costly mistakes by ensuring only legitimate ACH payments are processed.
- Improve cash flow control. Keep better track of outgoing payments and prevent unexpected debits from disrupting your finances.
A Smarter Approach to Preventing Internal Fraud
Internal fraud can be challenging to detect, but businesses can significantly reduce their risk with the right safeguards. A strong fraud prevention strategy combines internal controls, financial oversight, and technology-driven solutions to stop theft before it happens.
At First Business Bank, Treasury Management is a key focus, giving businesses access to a dedicated team of experts who understand fraud risks and how to prevent them. Along with innovative fraud prevention solutions, our clients also have a real person to call when they need support. We work with businesses to implement custom fraud prevention strategies that strengthen financial security, improve oversight, and give them greater control over their finances.
