Fraud prevention for manufacturers

Fraud in any business creates a variety of issues – it affects your bottom line, profitability and long term growth opportunities. It causes a drain on your resources, has a negative impact on morale and customer confidence, and reduces shareholder and investor trust.

Manufacturing firms are particularly vulnerable to fraud because of risk factors including high levels of raw materials, and finished and work in progress goods, which make inventory fraud and non-cash theft more likely. Bribery and corruption can occur when contracts are awarded or gained, and new technology and automation are areas that can also be exploited.

According to the ACFE 2022 report[1], a typical fraud lasts for 12 months before being detected and almost 50% is committed by employees in accounting, operations, sales positions and those at executive or upper management level. The manufacturing sector was found to be the third worst affected sector for fraud after banking and financial services and government and public administration!

Fraud can have a devastating effect on your business and should therefore be something that you include in your risk management programme.

Fraud is often difficult to spot as the perpetrators are likely to be covering their tracks. Typically fraud is carried out by an individual that has been at the organisation for between one to five years and is trusted. They will have inside information on systems and understand how the business operates, which allows them to find ideal ways to commit fraud.

Here are eight common areas that manufacturing firms are susceptible to fraud in:

Unmonitored supply chains

These are particularly vulnerable areas if supply chains are long and complex, with multiple sites and inter-related components. They provide lots of opportunities for fraud to occur.

Inventory assets

This is a common target for fraud in a manufacturing organisation. It involves the theft of physical inventory items or the misstatement of records on the business financial statement. It can be carried out by employees who are stealing stock or by the business itself to deceive shareholders.

Licenses and permits

Often required by the Government, the need for permits and/or licences can lead to bribery or kickbacks.

Counterfeit goods

These could come into the business from external parties as components that are required in the manufacturing process, or the business itself could produce counterfeit goods to reduce costs.

Billing fraud

Also known as invoice fraud, your supplier could advise that payment details have changed and provide different details in order to defraud you. This could occur in conjunction with staff from within your business who are in on the scam and gain a slice of the misappropriated funds.

Expense claims fraud

This occurs when an individual knowingly makes a claim for expenses at an inflated level, to which they are not entitled.

Embezzlement

This fraud occurs when a trusted employee steals or misappropriates monies or assets in their care, or that belongs to the business.

Non-cash theft

Just as it sounds this is the theft of inventory, equipment or services etc from the business that are not cash related. It can be carried out by issuing false packing slips, creating false shipments and asset requisitions, for example.

With so many ways for fraud to occur within your manufacturing business, you might feel that preventing it is unlikely. However, there are ways to detect fraud occurring and some steps that you can take to stop it from happening in the first place.

There are some things that you can look out for to detect fraud occurring in your business. Here are six indicators that may mean fraudulent activity is taking place:

1. A large reduction in your inventory – regular stock checks will help you discover if product levels are not where they should be.

2. Connections between staff and vendors responsible for procurement – if these are unnaturally close or there is a change in the relationship, it may indicate that something underhand is going on. Auditing procedures, checking pricing levels and supplier contracts may help here.

3. An increase in invoice volumes, inflated invoices and multiple payments without the engagement of services. All red flags that something is amiss. Again a regular review of invoices and costs will help to identify any fraudulent activities.

4. Contracts awarded despite previous poor performance. This should certainly be investigated to ensure that the reason for the new contract is above board.

5. A sudden increase in complaints. This could indicate counterfeit goods are being used in sales to end users, or inventory fraud if the complaints relate to product delivery delays.

6. Kickbacks increasing company reserves, which can be received in exchange for the promise of an order. Any monies that suddenly appear in accounts without explanation should be investigated.

With so many opportunities for fraud, mitigating the risk in your manufacturing business should be a priority.

To prevent fraud in your business you should talk to your broker about implementing a fraud risk management programme. You can start this by carrying out a comprehensive risk assessment, evaluating your procedures and level of staff education. You should also evaluate third party risks, which can include counterfeit products that you unwittingly use in production.

Once you have an overview of the current situation you can set internal controls to help you detect and prevent fraud from occurring. This will probably include training via online courses for your staff and the implementation of new procedures, such as two person sign off for payments, improving paper trails and limiting the number of people with access to financial accounts. A regular review of these controls should be carried out to make sure they are working and being adhered to.

Making sure that employees know how to report suspected fraud and having procedures in place about what to do next if fraud is identified, should be created. The ACFE 2022 report stated that 42% of all frauds were detected by tips and more than half of all tips came from employees.

You can also make use of technology by setting your systems to monitor activity and flag unusual inventory volumes or payments. Your enterprise resource planning application (ERP) will be your first line of defence and can help you monitor for fraud risk. Implementing multifactor authentication (MFA) will also reduce the likelihood of fraud. You can find out more about MFA here.

Creating a strong anti-fraud culture where everyone that works for the company understands their responsibility to protect it is a key factor in prevention. This should be supported with a strong deterrent, so that anyone within the company, considering fraudulent activity knows the risk outweighs any potential financial gains. This could involve making it very clear that anyone found to be committing fraud would be dismissed and likely referred to the police, and if the sums involved were large enough, the incident would be referred to the civil law courts to recover lost assets.

All risk management plans should be reviewed and monitored on a regular basis and supported with a comprehensive insurance solution. Despite the best prevention activities, fraud may still take place and having the right insurance in place to protect your business from fraud may be vital to the prosperity of your company.

You should consider Legal Expenses cover, which could help you to engage legal representation and Commercial Crime insurance, which protects a company and its clients against direct losses caused by forgery or theft of money, securities or property by an employee or third party. This cover could prove invaluable should your business suffer an incident of fraud and will help you to prevent similar instances occurring in the future.

Time for expert advice?

If you would like to talk to risk management experts with extensive knowledge of the manufacturing sector, then please get in touch. We can help you to create a risk management programme that protects your business from the unexpected, including fraud.

Call to speak to an experienced commercial broker on 01480 272727 or send us an email at enquiries@barnesinsurancebroker.co.uk – we’ll be pleased to help you to protect your business and safeguard your future!

[1] ACFE Occupational Fraud 2022: A report to the nations