Vendor fraud schemes are one of the major challenges businesses face today. Fraud and billing schemes have ruined the financial fortunes of many, and have threatened the survival of some.
To effectively combat vendor fraud, organizations need to know how to identify them, practice due diligence, and establish effective internal controls.
In this post, you’ll learn what vendor fraud is, the different forms it can take, how to identify them, and most importantly, how to prevent them.
What is Vendor Fraud?
Vendor fraud happens when a vendor swindles a company using fictitious or bogus documents.
Sometimes, the fraudulent activity is orchestrated by a vendor acting alone. Other times, it is carried out with the assistance of an employee (this is more common). In some instances, fraudsters will team up to fleece money from multiple companies at a time. The segregation of duties may even involve a fake vendor.
Vendor fraud is difficult to detect and research has shown that it takes an average of 18 months to detect a fraud scheme committed by a vendor.
Understanding Vendor Fraud
Fraud happens when an individual uses deception to obtain financial benefits from an unsuspecting victim.
Usually, this individual is someone you trust. It could be a friend, your company accountant, or a vendor you work with. Other times, it can be a total stranger.
People commit fraud for three main reasons:
- Financial pressure. Job loss, indebtedness, etc., can pressure people into committing fraud or getting kickbacks.
- They see an opportunity to obtain illegal financial benefits (like false payments) without getting caught.
- A sense of entitlement. A vendor who feels underpaid will likely jump on any opportunity to defraud a company. They’re also more likely to keep a double payment or engage in overbilling.
Examples of Vendor Fraud
Vendor fraud takes many forms. Here are some of the common ones:
- Fictitious vendor: In this arrangement, an employee submits a payment request from a non-existent vendor or an actual vendor that never delivered any supplies.
When the company doesn’t exist, perpetrators use fake vendor information that looks like a trusted supplier. This false vendor data may include:
- Bank accounts that appear legit
- Fake tax ID numbers
- Non-existent mailing addresses or phone numbers
- Shell company name
- Fake vendor account number
2. Duplicate invoice payments: This happens when an employee duplicates invoices from a legitimate vendor, with the plan of diverting payments to an account of their choosing. The dollar amounts are typically lower to circumvent fraud risks and the chances of being discovered.
3. Over-billing: An over-billing fraud scheme occurs when a vendor pads up an invoice by adding supplies they never delivered or higher prices of delivered goods. This type of scheme is prevalent among vendors that supply in large quantities. The hope is that accounts payable will not have the time or tools for proper risk assessment.
This is why it’s critical to integrate an automated payment system that scans and matches paperwork instantly to prevent vendor fraud.
4. Bid-rigging: Bid rigging is a fraud scheme that involves a vendor offering monetary compensation to an employee with a strong influence to secure a contract and vendor payment.
5. Price-fixing: As you might have guessed, price-fixing happens when two or more vendors conspire to fix the cost of a contract at a price higher than normal. The company is left with no choice but to work with a bloated budget.
6. Check-tampering: This type of fraud occurs when an employee tampers with the check of a legitimate vendor using forgery. The goal, as always, is to divert funds for personal gains. The most common form of check tampering is by changing the payee or amount.
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How to Identify Vendor Fraud
The key to combating vendor fraud…is knowing how to spot it. Here are measures your company can take to spot vendor fraud and conduct your own forensic accounting audit:
- Check the vendor’s pricing structure. If it looks too good to be true, it probably is.
- Scrutinize invoices submitted by or on behalf of a vendor as regularly as possible. If you notice two invoices with similar invoice numbers, a fraud scheme is probably at play.
- Also, check if the invoices were created using Microsoft Excel templates. If they are, it’s a big red flag.
- A vendor without a verifiable taxpayer identification number is very likely out to scam you.
- Run a background check on your new vendors to see if they are connected to your employees. Also, check if there’s any form of mutual relationship.
- Any vendor addresses that are a P.O. box typically denote some type of fraud.
6 Tips for Vendor Fraud Prevention
It’s not enough to just identify a vendor fraud scheme. What’s most important is how to prevent it from happening. Here are six helpful tips to prevent fraud schemes from vendors:
Tip 1: Effective Vendor Management
Winning the fight against vendor fraud schemes starts with having an effective vendor management system. With such a system in place, your company will find it easier to manage vendor risk efficiently; significantly reducing the chances of fraud.
Tip 2: Audit Your Vendors Regularly
Frequent vendor auditing can help guard your company against huge financial losses caused by fraud schemes. Start with the vendor master files and work your way through.
Tip 3: Employ a Multi-Level Payment Approval Process
Vendor fraud thrives in organizations where just one employee vets vendor invoices.
Hence, to prevent it, invoices should be vetted by two or more employees from different departments and at various management levels.
Tip 4: Use the Invoice Matching Technique
Invoice matching, when done right, can help reduce fraud occurrences to the barest minimum.
It’s a technique that involves comparing invoices submitted by a vendor against financial documents like purchase orders, payment receipts, inspection slips, etc.
You can choose to match the invoice against just one of the documents or all of them in a 3 way match, as the case may be.
Tip 5: Rotate Employees
Oftentimes, it takes the assistance of one or more employees to make a fraudulent scheme work without detecting a thing. Typically, it is employees in the procurement and accounting departments that are more likely to be involved in such schemes.
The best way to manage this risk is to rotate your employees by moving them across different departments over time. If possible, move them over to a different branch.
Tip 6: Run Regular Background Checks on Your Employees
If an employee is related or has a marital connection with a vendor, that’s a perfect setup for fraud. The only way to counter that is by regularly running background checks on employees against your vendors.
Unfortunately, you cannot eliminate vendor fraud. However, there are many actionable ways to reduce your risk of vendor fraud. Effective vendor management means a multi-level payment process, invoice matching, and continual rotation of AP employees.
You may also choose to go the professional route. There are certified fraud examiners that conduct quarterly or annual vendor audits, which can save you some real time and money.
By employing some of the prevention tips shared here, you can protect the finances of your organization from nefarious vendors, and focus more on growth and success!