By: Dylan Walter, Sr. Field Examiner

Clients face two types of fraud risks: 1) employees who misappropriate assets and 2) those who “cook the books” to make the company look healthier than it is. Ask borrowers if they’ve prepared such a profile that reflects both of these fraud risks. After all, managing fraud risk is instrumental, to not only your customers’ success, but also yours.

The checklist below can help you create your own customized fraud risk profile for each of your borrowers. The left side identifies some of the most common risks. The right side shows a borrower’s relative risk on a scale from 0–5. A score of 0 means there’s no risk. A score of 5, however, indicates an imminent threat of material loss or misstatement with very few controls in place to mitigate risk.

If you’re not sure about the appropriate rating for any factor, contact your customer for more information.

Fraud Risk Checklist

 

Potential fraud risk factor

Rating

(0-5)

Excessive pressure. Evaluate if conditions exist that may tempt employees to massage the numbers, such as expiring credit lines, deteriorating financial performance and performance-based compensation.

 

Informal attitude. Determine whether fraud risk management is a top priority or is done simply to satisfy external auditors or the board of directors. Evidence of having formal fraud risk policies that includes internal audits, computer passwords, surveillance cameras, whistleblower hotlines, formal job descriptions, and corporate codes of conduct.

 

Changes. Pinpoint any major changes — such as updated accounting software, a new product line, a pending merger or acquisition, insurance claims or lawsuits, or IRS audits — that could offer opportunities to conceal fraud or result in a significant monetary loss.

 

Volatile industries. Assign higher scores to volatile industries that have high growth and failure rates, significant competition, strict legal regulations, and imminent changes in product obsolescence and technology.

 

Unusual activities. Look for unusual activities that may warrant additional investigation, such as the use of complex business transactions, accounting estimates, competitive bidding, proprietary intellectual property, offshore activities, related-party transactions, and contingent assets or liabilities. Also, look beyond the footnote disclosures for clarity.

 

Personal problems or conflicts of interest. Be wary of employees who have close relationships with suppliers, co-workers, competitors and customers — or financial interests in other companies. Also look for employees who have problems with addiction, gambling, or legal and credit problems.

 

Internal turnover. Consider whether the business has changed owners, managers, accountants or attorneys, or lenders in the last five years. Unreasonable demands or frequent disputes could signal that the company is in crisis.

 

Cash. Gauge how much cash the business has on-site and where it (and the company checkbook) is stored. Mitigate risk by performing background checks on employees who might handle cash, independent bank statement reconciliations and physical controls.

 

Receivables. Look for a stable relationship between sales and receivables (as well as receivables and total assets) over time. And evaluate write-offs and aging schedules.

 

Inventory. Evaluate controls over shipments, inventory receipts and write-offs. Consider ways a fraudster can pilfer inventory or manipulate records for their own personal gain. Ask your CPA to perform physical inventory counts annually to identify discrepancies with perpetual inventory records.

 

Fixed assets. Ask whether the business prepares a detailed fixed asset register and tags high-value assets, such as printers, scanners, phones and computers. Keeping a routine maintenance schedule can help the client track the whereabouts and condition of each item.

 

Payables. Look for payable fraud schemes, such as kickbacks and phantom vendors. Borrowers must take steps — such as confirming vendor balances and duplication of duties — to mitigate payable fraud risk.

 

Improper revenue recognition. Evaluate the business’s policy for recording sales. Some may prematurely book sales to either boost earnings or delay recognition to minimize taxable income. Also look for fictitious customers and excessive refunds, returns, discounts and voids.

 

Lax expense review. Ask the management team how they verify fees paid for services, such as rent and professional fees — because there’s no physical evidence of the expenditure, except a contract or invoice. Strong customers will also have formal expense report approval procedures.

 

Fraud risk profiles can help you identify your borrowers’ weaknesses, and expose which areas warrant additional due diligence. Often, lenders and borrowers will independently rate the company and then compare the results. This exercise can serve as a springboard for discussing risks, opportunities and perception gaps with your customers.

Contact Us

ABLFreed Maxick’s Asset Based Lending division is one of the nation’s largest providers for field exam outsourcing services. If you have questions regarding your asset based lending issues, give our Buffalo NY office a call at 716.847.2651, or you may contact us here.

 

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