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Excerpts from the article “Business Fraud” by the Credit Research Foundation
When it comes down to it, business credit, no matter how professionally managed, is based to some extent on trust. In fact, the word “credit” itself is derived from the Latin credere, to believe or trust. A loan is creditum; money given “in trust”.
Credit fraud is a violation of that trust. It's a breaking of faith between customer and creditor. Every company is susceptible to credit fraud because every company wants (and needs) to make sales, and so must believe in their customers' pledge to pay. And, in most cases, this trust, within well-defined limits, is warranted. But there are cases in which unscrupulous individuals seeking to make a fast buck are going to do their absolute best to deceive you. The most effective defense to keep the hand of the thief in his own pocket and out of yours is to learn the game.
"Bustouts" or "Overbuys"
The point of this type of criminal activity is to obtain large amounts of merchandise without paying. Bustouts are often well planned, highly organized and involve substantial financial backing. Merchandise obtained in this manner is often sold below cost to other illegitimate businesses, at "flea-markets" or peddled door-to-door.
How it works: The swindler places small orders with a few suppliers and pays promptly. These suppliers are then used as credit references for larger and larger orders. Payments become slower and slower and eventually stop altogether, sticking the creditors with huge bad debts.
Hit and Runs
A swindler moves into a location and orders merchandise COD, paying with phony certified or cashier's checks. By the time the counterfeit check bounces, the "skip artist" has moved on to a new location to repeat the fraud.
These are “respectable citizens” who keep up their credit reputation in their home town. By using different trade styles, keeping their operations small, and limiting their victims to "out of towners," these con artists manage to fraudulently purchase and resell thousands of dollars in goods while indefinitely avoiding criminal prosecution.
Credit Fraud Targets
While any company can be a target for trade credit fraud, certain industries have special appeal to credit thieves. Wholesale and manufacturing companies dealing in these products find themselves in the sights of swindlers:
- General merchandise, including housewares, health and beauty aids, and electronic items like radios, stereos, VCRs and TVs, computers.
- Small items. The unscrupulous prefer products that can be easily moved, are difficult to trace and quick to sell.
- Low-to-medium priced apparel.
In this day and age, a company is asking for trouble if it hasn’t established strict credit policy, which it follows meticulously. Before granting significant lines of credit:
Thoroughly Check Company Ownership and Affiliations
Criminals in the business of fraud know that a careful businessperson will likely check on the ownership of a company and its principals before granting credit and shipping goods. Therefore, they try to make it impossible for you to find out exactly with whom you are doing business.
Insist on the name and phone numbers of companies with whom the principals claim past employment so you can confirm their business background. Get specific information on claimed affiliates, including addresses and telephone numbers. And, double-check all information.
Then, watch out for:
- A very young owner or principal. Using a "front man" conceals the true ownership of the company by individuals with questionable backgrounds. One of the con artist's favorite fronts is a very young person, because they will not have to invent a long business background.
- An older, retired principal. Older individuals also make good "fronts" if they retired with clear business records and are willing to be used to confer respectability on a dishonest operation.
- Hard-to-confirm employment records of the principals. The business backgrounds of a company's management should be specific and easy for you to check. Watch for a principal claiming long periods working: (1) in an obscure company in a foreign country; (2) for several companies now out of business; or (3) as a consultant -- particularly if he will not provide references or specific business locations from that prior employment.
- A confusing, complex organizational structure, especially in a relatively new business. Unscrupulous principals may hide behind a maze of complicated corporate or partnership entities (probably false) so that creditors find it difficult to check on the company.
- Mystery Affiliates. Fraudulent firms may try to convince you that they are part of a large, expanding business with many resources backing them. They claim to have parent companies, related businesses, branches, or subsidiaries that do not exist.
- A claimed relationship to a well-known, legitimate company. Businesses attempting to look legitimate sometimes represent themselves as subsidiaries or branches of well-known, legitimate companies.
- Difficult-to-confirm foreign ownership. Phony foreign parents are popular with merchandise swindlers.
- A "familiar" name that’s not “quite right”. A firm with a name that is uncomfortably close to the name of a well-known company could be trying to “cash in” on that company’s reputation.
- The "big" name -- an impressive, nondescript trade style. Some of the favorite words used by these fraudulent firms are International, American, U.S., European, Atlantic and Pacific.
Confirm the Buyer’s Location
You probably can’t visit each new customer’s place of business. But there are other ways to get a reasonably good feel for the business’ authenticity and stability.
- Ask how long the business has been at its present location. Then check with an outside source or the building's management to confirm the information.
- Have a trusted supplier or customer in the area stop in or drive by the new buyer’s place of business for you.
- Ask the credit references how long they have been selling to this buyer. This helps you determine the length of time the company has been in business.
Earmarks of fraudulent operations:
- They generally use short term, low rent locations, and move frequently. Additionally, watch out for strip "mini-warehouse" locations, which can be utilized to quickly move inventory to walk-in buyers.
- They often utilize mail drops to give the impression of an actual physical address.
- They may provide an address that is inappropriate to the type of business they profess to be doing. Residential areas are unlikely locations for wholesale, retail or manufacturing firms.
- Their ship-to address may be different than their business address. You may be shipping goods to a temporary location from which they will soon disappear.
Take A Second Look at the Credit References
References may not be all they seem at first glance. Re-examine references with a critical eye.
- When checking references, be sure to check the size of the orders for which the credit was granted. They should be consistent with the size of the order submitted to you.
- Be suspicious if a reference provides an instant "glowing" account without taking time to consult records when you call.
- Take care when you are provided with a specific extension, and told to "Ask only for Joe". Friends, relations, partners, even answering services can be used to provide a false confirmations or references.
- Beware of hard-to-trace fax numbers supplied as the only way to contact references. They may all lead to a single location which responds to reference checks using a variety of business names.
- Check a reference company by confirming, through outside sources like the Yellow Pages, that it is truly an existing business. Be sure the individual you speak to actually works for the reference company and is in a position of authority.
- If provided with an 800-telephone number, ask your customer or the referenced business for the local number - then call it and confirm the location.
Thoroughly Review Any Financial Statements
Extending a significant amount of credit is giving a loan. You have every right to require audited financial information before shipping the goods. (See our article, Credit Extensions Are Loans)
Then, once you have the financial statement, do not make a judgment from a quick perusal of the bottom line or the cash figure.
- Look for the name of the outside firm that performed the audit. A CPA listed as the preparer should be checked with the appropriate state licensing board. If the business and the accountant are located in different states, find out why.
- In the case of a new business, carefully check the stated worth and starting capital figures to be sure they are consistent.
- Review assets to determine if they can be confirmed by other sources. In the case of accounts receivable, they should be consistent in size with annual sales.
- Call the company's primary bank for a reference - specifically the average balance. If the bank says, "low three figures" and the cash on the balance sheet is $560,000, something may be amiss.
In addition, watch out for:
- Randomly dated statements. Accountants' statements are usually prepared at the end of a month, quarter or year. Not on May 17th or October 21st.
- Inflated assets. Assets that are impossible to confirm, such as marketable securities or real estate, may be suspect. Also, accounts receivables shown in rounded figures and/or in extremely high amounts are questionable. A large "due from officers" should be checked as well.
- A financial statement heavy on assets but low on debt. If it looks too good to be true, it probably is.
Take Extra Care with New or Unsolicited Customers
- Do not grant instant credit to a brand new customer – not even if the reason for a “rush” sounds plausible, or they threaten to take their business elsewhere.
- Be wary of a sudden flurry of telephone calls for credit references on a new customer. It may be using you to set up credit with other companies it intends to defraud.
- If you are selling directly from a wholesale establishment and the customer wants to take the merchandise immediately, insist on cash-and-carry.
- The customer avoids giving you hard information. They may act excited but vague, emphasizing what a great opportunity this is for you. It may truly be a great opportunity … a great opportunity to be cheated.
- The customer makes a case for "urgent" delivery. For instance, they need the order before a trade show, or to fulfill orders for a promotion already underway. Brand-new customers pressing for immediate, emergency or rush shipments on credit may be high risks.
- The new customer seems very familiar with your credit policy. For instance, the initial orders fall just under an amount that would trigger a more stringent credit check.
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The above information was provided with permission from the Credit Research Foundation (CRF).
CRF is an independent, member-run organization, consisting of a dynamic community of like-minded business professionals with a vested interest in improving and fostering the field of business credit -- more specifically--the practices and technologies of business credit.
Since 1949, the Credit Research Foundation has emphasized the role of education and research activities to aid business credit, accounts receivable and customer financial managers. CRF is the foremost non-profit, member-supported, education, and research organization dedicated to the credit and financial management community.
Membership in the Foundation is open to all individuals and businesses who have a vested interest in the credit, A/R and customer financial relationship.