Lapping in small business fraud

Lapping is a deceptive practice of hiding the theft of cash by using incoming funds from subsequent transactions to cover up previous thefts. This type of fraud can create significant financial discrepancies in small businesses. Understanding lapping, its detection, and implementing effective prevention strategies are crucial to safeguard the financial health of small businesses.

Defining Lapping

Lapping occurs when an employee steals a payment intended for the business and covers up the theft by using payments from other customers. For example, if an employee steals a payment from Customer A, they will then use a payment from Customer B to credit Customer A's account, and so on. This creates a cycle where the employee is constantly using new funds to cover up the stolen amounts, making it difficult to detect the fraud.

Detecting Lapping

Detecting lapping requires vigilance and a thorough examination of financial records. Here are some best practices for identifying potential lapping activities:

1. Regular Account Reconciliation: Regularly reconcile customer accounts and payments with bank deposits. Discrepancies between the amounts recorded and the amounts deposited can indicate lapping. Ensure that any irregularities are investigated promptly.
2. Review of Aged Receivables: Conduct regular reviews of aged receivables reports. Lapping often results in older accounts being settled with newer payments. If there are consistent delays in applying payments to the correct accounts, it may signal lapping.
3. Segregation of Duties: Implement strong internal controls by segregating duties among employees. Ensure that different individuals are responsible for receiving payments, recording transactions, and reconciling accounts. This division of labor reduces the opportunity for lapping to occur unnoticed.
4. Mandatory Vacations: Enforce mandatory vacations for employees handling cash and receivables. Fraudulent schemes like lapping often require continuous management. When an employee is away, it becomes harder to maintain the cover-up, potentially exposing the fraud.
5. Audit Trails: Maintain detailed audit trails of all transactions. Ensure that all changes and adjustments to accounts are logged and reviewed regularly. Anomalies in these records can point to lapping activities.

Preventing Lapping

Preventing lapping involves creating a robust system of internal controls and fostering a culture of accountability. Here are some strategies to prevent lapping:

1. Employee Training: Educate employees about the importance of ethical behavior and the consequences of fraud. Training programs should include information on recognizing and reporting suspicious activities.
2. Implement Technology: Use accounting software that provides automatic reconciliation and detailed reporting. Such systems can flag inconsistencies and reduce the risk of manual manipulation of records.
3. Frequent Audits: Conduct regular internal and external audits. Surprise audits are particularly effective in detecting fraudulent activities like lapping. Regular audits also act as a deterrent to potential fraudsters.
4. Segregate Duties: As mentioned earlier, segregate duties to ensure that no single employee has control over all aspects of financial transactions. This reduces the risk of collusion and makes it harder for lapping schemes to go undetected.
5. Encourage a Whistleblower Program: Create a safe and anonymous way for employees to report suspected fraud. Encouraging whistleblowing can help uncover fraudulent activities that might otherwise remain hidden.

Conclusion

Lapping is a sophisticated and deceptive form of small business fraud that can severely impact financial stability. By understanding the mechanics of lapping, implementing stringent detection methods, and fostering a culture of integrity, small business owners can protect their assets and ensure the accuracy of their financial records. Regular monitoring, employee education, the strategic use of technology, and strong internal controls are key to combating lapping and safeguarding the long-term success of a small business.