Keeping an eye on a company's money goes beyond simple cash accounting. In the digital era, instances of fraud from third-party vendors are on the rise. As fraud schemes become more sophisticated, fraud prevention methods must become more diligent.
Fraudulent activity costs companies thousands of dollars in lost cash, legal fees, and diminished financial power. In the extreme, fraud affects your creditworthiness and access to funding.
This article covers how vendor fraud occurs and what organizations should do to avoid fraudulent activity and its effects. We’ll answer several common questions about vendor fraud:
- What is vendor fraud?
- What are some examples of vendor fraud?
- How can companies identify vendor fraud and its risk factors?
- What are the best methods to prevent vendor fraud?
What is vendor fraud?
Vendor fraud is the intentional manipulation of pricing or goods perpetrated by a supplier. The goal is to increase internal profits and divert money to a third party (also known as embezzlement).
Vendor fraud can take different forms. It may involve a single bad actor or result from coordination between an internal employee and an outside vendor. Vendor fraud is a common and expensive risk to businesses. According to the Association of Certified Fraud Examiners (ACFE), companies lose 5% of their revenue to fraud.
Examples of vendor fraud
There are several ways internal employees and external vendors perpetrate fraud within the purchasing process, and some forms are more difficult to spot than others. Sometimes, the fraud is vendor-initiated through billing schemes or payment scams. Other times, an internal employee benefits from fraud by getting kickbacks or other incentives. Most fraud involving employees is for simple personal gain.
In general, companies must monitor for several common types of vendor fraud.
Fake company payments
Fake vendor payments occur when an internal employee and an external actor conspire to funnel money away from the company through illegitimate transactions. In most cases, fraudsters create a fictitious vendor (also called a shell company) and associated bank accounts.
The shell company employee generates fake invoices and transmits them to the internal employee, who then ushers them through the payment process. In another version of this fraud, the internal actor may change a legitimate supplier's account to divert funds into a separately held account.
Check fraud is one of the better-known sources of procurement fraud due to its relative ease of execution. In this type of fraud, an internal employee obtains checks to company accounts used for vendor payments. They then change the beneficiary or falsify a vendor signature to divert funds into an unauthorized external account.
Check fraud is most common in organizations that still rely on a manual and paper-based payment process. This type of fraud may be difficult to track without forensic accounting activities.
Most duplicate payments are inadvertent. However, invoice duplication presents an opportunity for vendor fraud in less secure accounting practices. In this case, a bad actor changes the vendor account, diverting the double payment to an external account. If the accounting system has no means to detect or prevent duplication, this type of fraud can occur repeatedly.
This type of fraud may occur without the aid of an internal actor. In this case, a vendor artificially inflates invoices by adding additional goods or services. The buyer then pays for products or services they will never receive.
Price fixing is a less common but more insidious form of fraud where several competitors in a market or industry artificially inflate their pricing in a coordinated effort while appearing to remain competitive. Price fixing is an illegal activity regulated by the federal trade commission (FTC). Even in cases where the fixed price is not a premium price, the anti-competitive aspect of this activity breaks the law.
How to identify a fraudulent vendor
Many fraudulent vendor activities carry certain hallmarks. Meeting one of these criteria does not necessarily indicate vendor fraud, but meeting several may require some extra research to ensure security:
- Vendor addresses or payment information originating from high-risk or international locations
- Mailing information that includes a PO Box only
- Companies that do not have common tax ID numbers such as an Employee Identification Number (EIN), Value Added Tax (VAT), or Economic Operator Registration and Identification (EORI)
- Vendors without standard contact information or phone numbers
- Repeated orders that fall below reporting thresholds or internal approval limits
- Invoice payments that deviate from the standard internal payment process and controls
- Whole-dollar invoices and transactions
- Invoice numbers that don't follow the vendor’s standard numbering convention (for instance, with an unexpected hyphenated, numerical, or alphabetical suffix)
- Differences between payment and delivery addresses
- Payments to a known vendor that far exceed the typical or expected invoice total
If you detect suspicious activity with a known, trusted vendor, take the time to research the discrepancy and work with your vendor to reach a resolution. If fraud occurs on a corporate card or other corporate account and cannot be resolved with the vendor, consult the card issuer or your bank for further action.
7 Ways to prevent vendor fraud
Catching fraud is tricky, especially in a manual accounting process. Use these best practices to reduce the risk of fraud and increase the opportunity to spot it when it happens.
Conduct onboarding due diligence
Take the time to learn about new vendors. Conduct a standard onboarding and risk assessment process for each new supplier in your organization. Consider using a security questionnaire to establish a risk profile at the beginning of the supplier relationship.
An ironclad approval process is the best defense against fraud. Use a multi-step approval process for every purchase and invoice payment to prevent fraud from continuing unchecked. Your approval workflow should check the purchase order or purchase requisition against the bill of lading and vendor invoice. This provides security against inflated or inaccurate invoices.
Increase spend visibility
Increase the level and frequency of spend analysis and reporting in your accounting process. This improves your cash optimization and creates an unfriendly environment for fraud. Use best practices and software to gain line-level visibility into spending and thereby reduce third-party vendor risk.
Centralize vendor info
A decentralized system creates opportunities to hide financial activity in the accounting process. Centralizing vendor information creates a source of truth for each vendor's address and account information. This prevents internal actors from making unnoticed changes to shipping addresses or external bank accounts.
Use only preferred vendors
A pre-authorized list of verified vendors ensures that every vendor in your supply chain is verified and approved for use. A procurement platform like Order.co provides strategic sourcing from a network of over 15,000 preapproved suppliers within a secure system.
Detect red flags
Automatic detection of account changes and unusual account activity is one of the best defenses against fraudulent activity. This includes duplicate detection, change notifications for vendor information, and spend analysis features to detect unusual or outlying activity.
Use vendor management software
A procurement or vendor management system automates many processes that enable fraud in manual systems. Use a platform like Order.co to strike a balance between accessibility for stakeholders and risk reduction for the accounts payable team.
Reduce your vendor fraud risk with Order.co
A procurement platform like Order.co reduces the potential for bad actors to perpetrate fraud. The Order.co platform offers several key features to make sourcing and procurement more streamlined and secure:
- A preapproved network of over 15,000 vendors to meet every stakeholder's supply needs
- Centralized vendor information with full visibility into ordering information and activity
- Electronic vendor payments that eliminate duplicate payments and the need for paper checks
- Spend analysis that provides line-level detail and analysis for every transaction
- Three-way matching for invoices to ensure the accuracy and completeness of orders
If security is a priority for your procurement process, Order.co has solutions to modernize your process and reduce risk. Schedule a demo of Order.co to see it in action.
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