Fraud Spotlight: Cutting Costs or Cutting Profits

fraudAs I have mentioned in previous posts, many companies have focused intently on cost reduction following the 2008 recession. At such times, it is easy to lose sight of the big picture and treat all costs as equal and assume that any reduction in cost is a net positive to the bottom line. This is a mistake.

For example, one common area for cutting costs is to reduce inventory levels. In short, less inventory means less rent, fewer warehouse employees, lower utilities costs, lower risk of obsolescence, etc. On the surface, it sounds like a no-brainer. However, there is a risk going the other direction; namely, the risk of not having enough inventory and realizing delays in fulfilling customer orders. This scenario also has costs, such as expedited freight, late fulfillment charges from customers, and even lost customer relationships.

In short, costs incurred to warehouse inventory are not simply costs of doing business but represent an investment made by the business that provides a return to the bottom line. Indeed, if cost cutting were the sole issue, a company could simply not hold any inventory and reduce inventory holding costs to zero. This, however, would not likely be good for the profitability of the business. As such, the real question is determining the level of inventory that provides the greatest overall return to the business.

Now let’s apply this logic and analysis to fraud risk management. During times of cutting costs, programs such as an internal fraud risk management program may be one of the first to get cut. Many businesses don’t even have such a program in the first place. If there have been no known fraud incidents, any costs spent to assess fraud risk, review and test fraud related controls, or remediate deficiencies in processes and procedures may appear wasteful and superfluous.

Again, this is a mistake. While the benefits of an effective fraud program (i.e., prevention of fraud) may be difficult to appreciate, the costs of fraud are well documented. Since estimates of typical losses due to fraud generally range in excess of $100,000 per incident, the return to the Company of preventing and detecting fraud in a timely fashion is worthwhile even if you assess a relatively low probability to the likelihood of occurrence. It should also be noted that the estimate above is per incident. At any point in time, a business will have multiple risk points where fraud could occur. Failure to address these risk points could result in multiple incidents occurring at the same time. Add to the mix the low recovery rate on fraud losses and the case for proactively managing fraud risk begins to take shape.

My message is that fraud prevention efforts are not merely an extra cost to be considered when the business is doing well but an investment that provides a real return to the business. When done correctly, fraud risk management will enhance a business’s reputation with its stakeholders and the bottom line.

The fraud word of the week: Cozen

Be careful that you are not cozened by some dishonest person.

Brian Davidson

My specialization is in the areas of assurance services, fraud risk management, and forensic accounting. I am energized by bringing insight to customers regarding their business and assisting customers in identifying and addressing significant business risks. I am also passionate about the truth and being an advocate for accuracy and integrity in financial reporting.
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