How to Spot Fraudulent Financial Statements

Evaluating a company’s financial statements can help credit professionals determine the creditworthiness of current or potential customers. However, sometimes fraud is committed within the highest company levels to deliberately alter these financial statements. That is why credit professionals need to be better educated at spotting distorted financial information on a company’s financial statement. This was the purpose of a past CMA webinar presented by Bruce Dubinsky, MST, CPA, CVA, CFE.

Dubinsky said credit professionals should ask one simple question when reviewing financial statements: “Does it make sense?” Dubinsky pointed out that certain information on a financial statement could send out a red flag that something is wrong. If that happens, a closer inspection of what went into the reporting of that information would be prudent. He said, “paper talks in different ways,” and offered tips on how to identify those things that should “jump out at you.” While some personnel may make some honest mistakes in preparing their company’s financial statements, Dubinsky noted that some company officials deliberately provide false information. When this occurs, it is fraud, which he defined as “one or more deliberate acts designed to deceive other persons and cause them financial loss.”

There are a number of ways people commit fraud. Some include the encouragement of investment through the sale of stock; demonstrating increased earnings per share or partnership profits interest thus allowing increased dividend/distribution payouts; covering the inability to generate cash flow; obtaining financing, or more favorable terms on existing financing; dispelling negative market perceptions; receiving higher purchase prices for acquisitions; demonstrating compliance with financing covenants; meeting company goals and objectives and receiving performance-related bonuses.

Financial statement fraud typically occurs through the overstatement of company assets and income and the understatement of liabilities and expenses, Dubinsky noted. Conversely, bankruptcy financial statement fraud typically occurs through the understatement of income and assets and the overstatement of company liabilities and expenses. For bankruptcy, the motive for committing fraud is to understate what the company is worth to its creditors. Therefore, it is important to determine the motives behind the presentation of a financial statement in order to figure out what type of fraud may exist on the statement. For example, overstating assets and income and understating liabilities and expenses could be designed to entice investors, to get bank loans, to obtain vendor credit and to get an inflated price in the sale of the business. The understating of assets and income and the overstating of liabilities and expenses could be motivated by a bankruptcy, divorce or, in shareholder disputes, as a way of reducing financial exposures. “Most times, fraudulent financial statements are used to deceive people to gain credit,” Dubinsky added. “Learning to understand the motive of why financial statements are submitted to you will give you a heads up of detecting fraud.”

Audited financial statements are no guarantee that the numbers haven’t been fraudulently manipulated. Dubinsky pointed to famous corporate financial fraud cases such as Worldcom and Enron that had audited financials. Audited financial statements are not designed to detect fraud, only verify that the numbers on the given financial statements add up correctly. He offered several examples of financial statements that could provide very different results by altering certain elements on the statements that are hard to verify without further investigation, such as the value of inventory or accounts receivables. For accounts receivables, Dubinsky recommended getting aging schedules for the end of the month for the last 12 months to determine any trends. If there is a sharp drop in accounts receivables, for example, he said this could be an indication of fraud. In order to provide protection from relying upon a possible fraudulent financial statement, he advised asking for a security interest in a particular asset that has appreciated, such as land. Another tip he offered was to pick out businesses listed on a financial statement and do a Google search on them to see if they really exist, to guard against fictitious companies providing fictitious receivables.

Other advice Dubinsky offered was to read audit qualifications carefully to learn more information about possible financial downturns of the company. He also recommended asking for the management letter of an audit. “There may be things in there to make you look at the financial statements differently. I would highly encourage you, if you’re granting a credit request for a high dollar amount to conduct a site visit,” he added. “When you’re doing a face-to-face meeting with someone, you’ll be surprised what they’ll tell you.” As a general piece of advice when evaluating financial statements Dubinsky said, “Put your level of professional skepticism as high as it can be without hindering the performance of your job.”

CMA has offered other webinars on this topic. To view a list of past and upcoming topics, visit www.CreditManagementAssociation.org/events

What You Need To Know To Protect Your Business From B2B Credit Fraud by Sam Fensterstock, AG Adjustments

INTRODUCTION

We usually associate credit fraud with the impact it has on individuals in the form of identity theft or phishing scams and the personal financial problems it causes, but what about businesses? What is the incidence of B2B credit fraud and is it a major problem?

Yes, it is a major problem. According to credit reporting agency, Experian, B2B fraud costs US businesses “more than $50 billion annually” and most analysts believe that that number is too conservative. It is also assumed that the incidence of fraud will continue to increase as the use of various electronic payment methods continues to grow.

HOW EXTENSIVE IS THE PROBLEM?

For an overview of the problem let’s take a look at some results from the Association of Financial Professionals (AFP) “Payments Fraud and Control Survey”, published in March 2015:

Some highlights from this survey are:

  • 62% of companies were subject to payments fraud in 2014.
  • The most-often targeted payment method by those committing fraud attacks are checks. Check fraud also accounts for the largest dollar amount of financial loss due to fraud.
  • The second most frequent targets of payments fraud are credit/debit cards.
  • 92% of survey respondents firmly believe EMV- enabled credit/debit cards will be effective in reducing point-of-sale (POS) fraud. EMV- Europay, MasterCard and Visa — is a global standard for cards equipped with computer chips and the technology used to authenticate chip-card transactions.
  • 61% of survey respondents believe that Chip-and-PIN validation will be most effective in preventing credit/debit card fraud.

Business fraud can devastate a company and as there are very few external protections it is up to the business to protect itself. A company must be aware of the various types of fraud that it may be subjected to and develop methods for protecting itself.

WHAT ARE SOME OF THE DIFFERENT TYPES OF B2B FRAUD?

There are many different B2B fraud schemes. Here are a few of them:

  • Account Takeover: This is similar to the phishing and telephone scams that affect personal identities. Here credit card or account information is intercepted and later used to place orders or otherwise defraud a legitimate business. This particular type of fraud accounts for a large percentage of B2B fraud occurrences.
  • Business Identity Theft: Here a scammer opens business accounts under the name of a legitimate business. The applicant acts as the business owner (or a representative) and utilizes their contact information to apply for credit or open accounts.
  • Commercial Bust-out: The culprit opens several lines of credit with the intention of eventually abandoning them once the credit limits have been reached. This requires that a good credit history be fabricated so that limits can be increased and maxed out right before the perpetrator disappears. This type of fraud results in millions of dollars of losses every year.
  • Never Payment: Here a business or individual opens a new account, by materially misrepresenting itself. They will obtain the maximum credit possible, but never make a payment.
  • Shell Companies: These are companies that are set up solely for the purpose of committing fraud. The entity will not sell a product or provide a service. Many times they are used to launder money. They rarely have a physical location, and if they do, it may be a storefront or offshore.
  • Bleed-outs: This method of committing fraud is similar to a bust-out. However, it is committed from within by insiders. Employees commit this type of fraud over a long period of time. They bleed out assets, leaving the company unable to pay its bills.

SOME CHARACTERISTICS THAT MAY INDICATE A POTENTIAL PROBLEM

Individuals and groups committing these types of frauds will often display many of the same characteristics. The following are some of the things you should look for:

  • Companies Without Long Histories: Typically, companies with longer track records are safer to do business with because they will have more credit history and references to check. The shorter the life of the company, the less you will have to work with.
  • Suspicious Changes in Ownership: A well-established company, with good credit, is taken over by a new group that tries to hide the change in ownership. This may signal a potential problem. It may be an indicator that members of the new owners are committing fraud.
  • Questionable Financial Statements: Mistakes or suspicious items on a company’s financial statements may be a harmless accounting error or signal a real problem. A detailed financial analysis is necessary before doing business with this company.
  • Fraudulent Credit References: False credit references on a credit application are a warning sign to forget about doing business with this applicant. Unless the applicant can prove it’s a clerical error and has other good references, doing business with this entity is an invitation to be scammed.
  • No Receivables: If a company’s financial statements do not list any receivables, assuming they are not a cash only business, they are probably a phony shell company that is not providing any goods or services to customers. Do not extend this company a line of credit.

HOW DO YOU PROTECT YOUR BUSINESS FROM B2B FRAUD?

Validate All Information

The easiest and most important step in B2B fraud prevention is to verify the information provided by companies that want to do business with you.

This means you need a credit application (see our blog on credit applications). All the information provided needs to be thoroughly reviewed and verified. Make sure everything on the application is accurate, and ask questions if it is not. Any material errors are a reason not to do business.

Additionally, if your business is contacted by a bank, credit card company, or government agency, don’t provide any sensitive information before verifying the legitimacy of their request.

Utilize External Credit Sources

A business can pull a credit report on another business to ensure that they are dealing with a credit worthy company. Unlike personal credit, which is protected by the Fair Credit Reporting Act (FCRA), anyone can pull a business’s credit report at any time without permission.

Utilize Fraud Detection Tools

Utilizing a fraud detection tool like Experian’s National Fraud Database allows you to compare credit applications and other information to current fraud records stored in a national database. If the applicant is in this database you want to be very careful about doing business with them. COD may be your only option.

Ongoing Transaction Review

Review your banking and credit accounts on a regular basis. Not doing so can leave you and your business a victim of fraud. Initially, transactions tied to fraud or illegitimate charges may not be large enough to indicate a problem, but by monitoring your accounts on a regular basis, you’ll be able to spot fraudulent transactions before real damage has been done.

Staff Education

Make sure you educate your employees on the various types of fraud and how to prevent it. You will sleep a lot better knowing your staff has the ability to protect your business against scammers and con artists.

CONCLUSION

B2B credit fraud is becoming more and more of a problem. Important business, financial and personal data are increasingly being compromised. Preventing and defending against B2B credit fraud is a challenge for companies. But you can limit your exposure and minimize losses due to such activity. Being aware of the problem is an outright necessity and implementing the protective measures described above will help reduce most of the risk of B2B credit fraud.

For over 40 years, AGA has been the most respected commercial collection agency in the nation. We assist corporations with improving cash flow, while preserving a positive image with customers. We accomplish this by employing the best and brightest talent in the industry, with low turnover and unparalleled tenure.

Detecting Fraud: Basic Checks You Should Do Before Extending Business Credit

With the recent rise in bankruptcies, it is more important than ever before to have a handle on business to business (B2B) risk management. More and more fraudulent companies are emerging, as business lines are being blurred from start-up manufacturers operating from a garage, e-commerce “e-tailers” businesses that may or may not be legitimate. Because of this, it’s tough for credit managers and risk management professionals to tell the good companies from the “bad” ones.

So what’s a credit professional to do? Here are several activities you can do before you decide to extend B2B credit.

  • Validate their address. With Google maps, you can tell more about the location of a business than ever before. Does their address come up on Google maps? Does the satellite view (photo) show that they’re a residence or a business? Are they located in an area where it would be impossible to do business (i.e., a forest)? Answering these location questions ahead of time could alert you to red flags of fraud before you take them on as a client.
  • Make them fill out a credit application and check and confirm their credit references. When you call their list of references, are they companies who’ve done businesses with them recently? Are the phone numbers of their references valid? Are the numbers for all companies mobile phone numbers, leading to the conclusion that these are individual numbers not businesses? Are the references related to the potential client? If any of this data they provide sounds fishy, it could be another red flag.
  • Visit the customer’s website. There are many red flags that can be gained by visiting the site, including poor design, phone numbers not matching those given in the references, broken image links and other items that can cause you to question the validity of the business.
  • Utilize your Industry Credit Groups. Utilize the knowledge of your fellow industry credit managers by bringing up any suspicious companies during your Industry Credit Group meetings. As we see repeatedly in Credit Group meetings, fraudulent companies tend to go to multiple companies in a particular industry until they get what they need. Additionally, anscers RFIs and alerts can help you on an as-needed basis, and CMA members get unlimited access to these alerts and RFIs.
  • Use credit reports and decisioning data to help. CMA provides access to reports from the major reporting agencies and also offers the NACM National Trade Credit Report, which aggregates information submitted to all of the NACM affiliates that is not typically provided to the major credit reporting bureaus. And better yet, CMA members who contribute their A/R information receive 25 free NACM reports per year.
  • If you’re in the construction industry, consider using THE Construction Credit Report, providing access to public record data; title search (with live links to actual documents) on mechanics lien filing/release; notice of completion; notice of Lis Pendens (action/discharge); tax lien or judgment; active trade lines; credit analysis and score; collection agency and factoring company activities; and links to state Registrars Of Contractors. For more information on this unique report, click here.

If you consider doing these tasks before deciding to extend credit, you’ll help eliminate obvious fraud from occurring, protecting your company’s most valuable resource, its accounts receivable.

What processes does your company have in place to help protect from fraud? We’d love to get your input!

Fraud Tips – Don’t be a target this season, by Michael W. Fenner, CBA

Wow…it’s hard to believe the holidays are just around the corner. We all know this time of the year we need to be more vigilant in regard to protecting our assets. I wanted to take a few minutes and list some bullet points to think about so you can share with your teams. I don’t have all of the answers so feel free to share your experience as well. You know if we close any potential loop holes now we will save our companies some money and hopefully minimize any possible theft this holiday season. Let’s make sure we all review our credit policies with our team members today.

Below are some tips about accepting checks and or credit cards:

  • Know your customer. – Have you dealt with this person before? If not, it might be a sign.
  • Avoid taking credit card payments over the phone from customers you don’t know. – It’s hard to verify the identity of the person on the phone. Have them come in to verify them and swipe the card.
  • The customer won’t show their ID. – Call the company number on the check to verify the person, call the bank to see if the account is open or closed. Chances are something will come out of the additional questions you are asking.
  • Is the driver’s license preprinted on the check or prewritten on the check already? – Still take the time to review and verify the customer’s identification. They could be trying to slip one by you.
  • Is a rental truck picking up the material? – Notify your yard personnel to keep an eye out for customers loading material into rental trucks. This is a very common sign.
  • Are they not from your area? – Is there ID from San Diego but they are purchasing from you in Los Angeles? They may have a job in your area but keep an eye out for this one.
  • How is the customer acting, are they nervous? – Are they avoiding eye contact, are they acting suspicious, being pushy after a very simple request?
  • Does the e-mail address match up with the company name? – Double check to see if the e-mail address matches up with the information on the check and or credit card authorization form.
  • An out of the area phone number. – Do they have an area code that isn’t from your area. Take a second look and confirm.
  • If it doesn’t feel right it probably isn’t. – We all have that gut feeling at times. Have your teams contact your credit department if they are feeling uncomfortable.
  • Did I mention know your customer? – Always make sure you know who you are dealing with.

Fraud can hit us many different ways, but it always bites us. They are always persistent and unyielding and it doesn’t matter where you are from New York to California. At times they are highly organized and very sophisticated. And other times they are by themselves looking for an easy target. Don’t be an easy target. As always keep your eyes and ears open.

Thank you for taking a few minutes out of your busy schedule to read my blog.

Please remember we need you to support “your” credit association when you can and as always “thank you” for your support. I encourage you to send in any ideas to improve your credit association. Let me know your thoughts. I’d love to hear your feedback.

Michael W. Fenner, CBA, is the Credit Management Association Chairman and Regional Credit Manager for Beacon Roofing Supply. He can be reached at 714-321-8187, or mfenner@becn.com.

Suppliers Accepting Credit Card-Present Payments Take Heed To Adopt New Technology By October 1, 2015 Or Bear Risk Of Fraud Loss, By Scott Blakeley

The Wall Street Journal reports that credit card use in the B2B space continues to increase as a preferred payment channel for customers. Suppliers accepting cards in the B2B space commonly receive payment through card not present forms, whether through payment portal, email, fax or over the phone. For those suppliers that accept cards in the cardholder’s presence, card issuers are changing card acceptance rules to give cardholders greater protections from identity theft.

“Chip and pin” or “smart cards” are credit or debit cards that store data on integrated circuits rather than on traditional magnetic stripes. The transition to “chip and pin” or “smart card” technology is now largely underway in the United States. The transition is being assisted by the shift in liability for card-present fraud that will be implemented on October 1, 2015.

Currently, if an in-store transaction is conducted using a card obtained fraudulently, cardholder losses from that transaction lie with the payment processor or issuing bank. From October onwards, that liability will shift to the supplier that has not changed its system to accept chip technology. If a customer uses a chip card, the failure to update the card reader may permit a counterfeit card to be successfully used. In that scenario, the supplier will bear the cost of the fraud. Again, the supplier will only be responsible for the cost of the fraud if the fraudulent transaction is a card-present transaction.

The major benefit of using a “chip and pin” payment card, and what compelled the US to migrate its cardholders to the new generation of cards, is improved security and fraud reduction. Whereas magnetic stripe card transactions rely on the holder’s signature and visual inspection of the card, the use of a PIN and cryptographic algorithms provide authentication of the card to the processing terminal and the card issuer’s host system.

The identity of the cardholder is confirmed by requiring the entry of a personal identification number (PIN) rather than signing a paper receipt. Unlike magnetic-stripe cards, every time a smart card is used for payment, the card chip creates a unique transaction code that cannot be used again. This eliminates the possibility of card duplication fraud as the transaction code becomes obsolete and cannot be used in further transactions.

While much of the rest of the world has already been using “chip and pin” cards for several years, the US is now committing to migrate its credit card use to this more secure format. There is a historical viewpoint regarding the reason for this delay by the US in updating its credit card technology standards. In the past, fraud was much more prominent in markets outside of the US. What has happened, especially over the course of the past few years, is that since other markets have migrated to “chip and pin” cards and become more secure, fraudsters have moved their focus to the US market. Essentially, they came to the US market because they were looking for less secure networks from which to steal fraudulent credit card information.

For suppliers in card-present transactions, the switch to this technology means adding new in-store technology and internal processing systems, and complying with new liability rules. For cardholders, it means activating new cards and learning new payment processes. And for the supplier and cardholder, it means a more secure form of payment by credit card, and fewer opportunities for fraud to occur. As the credit team is responsible for managing risk, including risk of fraud with payment channels, the credit team must prioritize compliance with this new technology within the organization for card-present transactions.
Scott Blakeley is a principal with Blakeley LLP, where he practices creditors’ rights and bankruptcy. His e-mail is: seb@blakeleyllp.com.

Chair’s Message: How to Spot Fraud, by Melissa Kobus

In today’s connected world, fraud is an epidemic that can hurt any company, big or small, and it’s becoming more common.

In my company, we recently were hit with some large fraud both with “phony” PO’s and stolen credit cards.  As credit managers, make sure that you are diligent about watching for the red flags so that we can stop these before we take a hit.  If something does not smell right, look right, etc. – ASK your credit analyst and investigate further.

Please pay attention to the following details when accepting orders (on terms or credit cards):

  • No contact except via email
  • Phone number is from outside the area or linked to Magic Jack phone
  • Urgency of getting a quote or in shipping material (must have it air freight today)
  • Email address is outside the normal address (gmail and yahoo too)
  • Reluctance to complete online forms
  • Typos and misprints on pre-printed information
  • Material type and quantity is out of the ordinary (hard drives, projectors, testers, etc)
  • Material has a high copper content and seems out of the ordinary for a credit card purchase
  • Shipment going to a different location or a location outside of their territory  (Use google earth to research ship-to address)
  • Shipment made close to a border town
  • Credit card number and name does not match the way the account is setup

Our best defense against fraud is a strong front line, so please make sure to keep your eyes open and ask questions, make phone calls, do the research.  We can continue to stop these thieves from hitting your company.

It is important to make sure everyone on your team gets this information.

What measures are your companies taking to prevent fraud? We welcome your feedback.

Melissa Kobus, CCE, is the Credit Management Association Chairman and Regional Credit Manager for Anixter Inc., based in Anaheim, CA. She can be reached at 714-695-2219, or melissa.kobus@anixter.com