By Mohan Ramaswamy, Co-Founder and CEO of Rubix Data Sciences
A simple Google News search of ‘Financial Fraud in India’ returns 44,90,000 news articles. Fraud in the Indian Business landscape has become an oft repeated word, with not just the quantum rising, but also the complexity (the NSE case for example). Let us look at some of the common types of types of B2B fraud that are taking place in India.
In this kind of fraud, perpetrators pose as owners/directors of an actual company and use its credentials to ‘do business’ with other companies. They get the actual company’s customers to route payments to the fraudulent bank accounts that they have set up or purchase goods on credit from vendors with no intention of making the payment.
When a firm deliberately falsifies information on a tax return to reduce its tax liability, it commits tax fraud. With the advent of GST in India, most tax frauds are related to fabricating input tax credit to show lower tax liabilities. This is done through invoices from fake companies and/or creation of shell companies to route fake invoices.
Money Laundering Using Tax Havens
In money laundering, an entity tries to pass off large amounts of money received through illegitimate means as having been received through legitimate sources. In the process, many companies use ‘tax havens’ to show the origin of this income. Money launderers use these havens to set up shell companies and park their money.
Siphoning Off Money From the Business for Personal or Other Purposes
Fraudsters may route, stash, or use funds from undisclosed bank accounts. They may inflate expenditure to siphon out cash or show a drastically lower income by doing transactions in cash and not revealing them (both common practices in India). They could even divert sales and opportunities to sister concerns or create imaginary assets to divert money. Some even falsify losses citing economic slowdowns or disaster events. Companies ‘buying’ other companies owned by known people or family at highly inflated costs also facilitate this kind of fraud.
Wilful Payment Default
This occurs when the indebted company deliberately avoids its payment obligation despite having the ability to honour it. It could be a loan repayment or payment to a vendor for goods provided or services rendered. Issue of post-dated cheques that are subsequently dishonoured is a practice that is quite common in India.
In this type of fraud, the perpetrators fabricate, omit, or overstate business data, resulting in the deception of the party they are engaging with. This could include bloating the number of employees, falsifying utility bills and bank statements, and even annual turnover and profitability data.
Indicators of Potential Fraud
Most types of frauds provide early warning signals or red flags that, if addressed swiftly, can reduce losses. These can be identified through vigilance, regular surveillance, and thorough scrutiny of abnormalities in a company’s key metrics which include:
● Significant fluctuation in operating and EBITDA margins not in keeping with industry benchmarks
● Significant variance in the ratio of material consumption to sales
● Interest and investment income are not in sync with the level of investments on the company’s balance sheet and applicable interest rates
● Finance costs are not in sync with borrowings and applicable interest rates
● Non-payment of debts even with high cash balances
● Uncharacteristically high levels of debtors compared to sales
● Unusually high levels of inventory compared to sales or production
● High level of loans and advances, particularly to related parties
● High level of intangible assets compared to industry benchmarks
● Long-pending capital work in progress
● High amount of deferred taxes
● Negative operating cash flows over a period of time despite revenue growth and operating profits
● Inflated marketing costs compared with industry benchmarks
● Abnormally high logistics costs
● Payroll irregularities
● Excessive concessions and rebates
● Abnormally high travel, conveyance, and entertainment costs
● A sudden spike in other income; may be due to fake or non-existent transactions
Prevention of fraud needs action at two levels: at the country level and within the company.
At the country level, higher corporate accountability, well-defined laws and regulations, stricter and swifter punishment of the guilty will deter people from perpetrating such frauds. At the organization level, a company needs to foster a culture of transparency and accountability.
This can be done through the following:
1. Strong internal control systems, processes, and MIS
2. Transparency and accountability at the senior management level to set the right ‘tone at the top’
3. Honest, professional, skilled, and well-intentioned board of directors that will not hesitate to raise red flags when required
4. Effective accounting and internal audit and statutory audit systems
5. Periodic checks of stock and immovable assets
6. Regular confirmation and reconciliation of books with lender, vendor, and customer invoices
7. Deployment of technological tools leveraging analytics, machine learning, and artificial intelligence to pick up early signs of fraud
8. Rigorous compliance with accounting standards for revenue recognition, fair value measurements, impairment of assets
9. Ensuring that decision-making powers are not concentrated; there must be a system of checks and balances at every level
10. Well-designed and fair compensation, benefits, and incentive system for employees
11. Implementing an effective whistleblower mechanism
12. Conducting regular fraud risk assessment internally and of supply-chain partners
13. Centralising the vendor database for better control
14. Having multi-level payment approvals
15. Conducting due diligence while onboarding vendors and regularly undertaking vendor audits
16. Clearly segregating duties of personnel receiving goods or approving services, those dealing with invoices, and those approving and making payments
17. Having a zero-tolerance-to-fraud culture that deals with and punishes perpetrators swiftly
Detecting and preventing B2B fraud is not a one-time effort. Constant monitoring and surveillance to detect any irregularities at all stages of a B2B transaction is the only way to minimise the risk of fraud. New technologies, tools, and platforms are available to help in the process of validating identity, conducting due diligence, and monitoring transactions with counterparties to red-flag potential fraud.