Occupational fraud, theft committed by employees, is not a new risk to dealerships, and the recent surge in dealership fraud could have been prevented with better internal controls and the power of technology.
Examples are:
- A general manager using dealership funds to buy trade-ins personally
- Service managers manipulating repair orders to fudge financial results and misappropriate funds
- Service advisors manipulating hours clocked by technicians to achieve efficiency bonuses
- Parts interpreters stealing parts for after-hours repairs
The list goes on as to the dealership fraud that has occurred in recent months.
These are not new ways of stealing from the dealership, what is new are the dollars involved (up to $100k+) and who is committing the fraud (mostly by management and collusion with multiple perpetrators).
Current fraud statistics show that if a dealer makes a profit of $800,000 (representing one per cent of sales), employee theft can eat into that profit to the tune of $600,000 leaving just $200,000 going to the bottom line.
The Association of Certified Fraud Examiners estimate that organisations lose 5% of revenue to fraud1 and that the median loss per incident was $145,0001 to an average loss per incident of $1.7M1.
Losing 5% of revenue to fraud may be considered unlikely at a dealership, and 5% of gross profit is more likely, however for most dealership groups, that would still be hundreds of thousands of dollars lost to fraud; and right off the bottom line in a time when making money has gotten a lot harder.
Why dealers are an attractive target
Dealerships have always been a target for fraud due to the large number of high dollar transactions and lack of segregation of duties, however after years of dealerships being bought and sold, certain natural protections from fraud that had existed have since been stripped away.
Dealerships now have:
- new owners with no personal connections to dealership personnel
- ownership and management are no longer the same.
In addition, times are tough for most people who have gone from making big money to much less. All these factors create an environment for an employee to commit fraud – pressure (earning less money), opportunity (lack of controls and oversight), and rationalisation (“I don’t owe the owners anything;” “I earned this;” “I will pay them back”).
What dealers can do to protect their assets
Dealers need to take a hard look at their business processes and controls to ensure they are operating the way they are supposed to in preventing and detecting fraud. Here are some effective and economical controls used to combat dealership fraud:
- Segregation of Duties
A lack of segregation of duties is always present when fraud has been committed at a dealership. When an employee has conflicting duties and access to sensitive DMS functions with no oversight, fraud typically follows.
This is a challenge to resolve in inflationary times when every dealer is looking to reduce expenses. However, using technology and a data mining platform (see #2 below), employees with access to sensitive DMS functions can be monitored effectively and at a much lower cost.
Another basic control is to have the monthly bank, vehicle and parts inventory, and floorplan reconciliations prepared by someone that is independent of the relevant functions e.g. the bank reconciliation would be prepared by someone that does not process or sign cheques, post deposits etc. Preparation of the reconciliations should include documented investigation and resolution of unusual items. These reconciliations should also be included in the month-end package that is provided to the owners/executive management (see #3 below).
- Data Mining Reporting and Procedures
Technology and dealership experience can be used to effectively monitor dealership operations at the transaction level. The power of data mining is that all relevant transactions can be analysed, not just a handful of transactions as with traditional monitoring methods.
A data mining tool extracts data from all departments and all areas of the business – general ledger, banking, payroll, finance and insurance, vehicle, and parts and service operational data – and reports on questionable transactions that can then be investigated. This type of reporting should be summarised and included in the month-end package that is provided to owners/executive management (see #3 below).
The reporting should be designed in line with what is important to the dealer and can vary month to month, some examples are:
- Cash disbursements/general journals posted by users with sensitive DMS functions and posted to unusual GL accounts
- New vendors for the period
- YTD and MTD wages by employees (management, controller, office manager, accounting, employees with access to sensitive DMS functions)
- Summary of counterperson override adjustments by user including quantity on hand adjustments
- Internal RO’s by service advisor closed to unusual GL accounts
- Month-end Package
A monthly reporting package should be provided to the owners/executive management for review so that they can ask questions about items they do not understand. At a minimum, the package should include:
- Management accounts including month-to-month trends
- Cash flow analysis
- Bank, vehicle and parts inventory, and floorplan reconciliations (see #1 above)
- Data mining reporting (see #2 above)
As part of their review, owners/executive management should download bank/floorplan statements direct from the provider website and ask about certain transactions from time to time.
If employees know that their bosses are looking, that might be all that is needed to prevent them from committing fraud. This can apply to any report given to an owner/executive management.
Also, the dealership should develop a culture of scepticism by everyone in the organisation, from the CFO approving a $1M wire transfer to the accounts payable clerk adding a vendor as instructed by the controller.
- Red flag behaviour
84% of fraudsters display at least one behavioural red flag1, which includes:
- Living beyond one’s means
- Financial difficulties, divorce/family problems
- Unusually close to vendors/customers
- Unwilling to share duties.
Dealership personnel tend to know when individuals they work with display red flag behaviour and having a hotline is the easiest way for them to alert owners/executive management anonymously. Conducting employee exit interviews is another way to learn of any issues in the dealership.
- Physical Security
It is common knowledge that dealership security (fencing, surveillance cameras, motion detector lighting) is crucial for protecting inventory and the safety of employees and customers.
Dealership security also acts as a fraud prevention tool, for example:
- after-hours access to the parts department should be prohibited and surveillance cameras installed to prevent personnel from stealing parts
- regular sweeps of the showroom and offices should be conducted to ensure personal information is not easily accessible for hackers to find and build synthetic ID’s.
Summary: Dealership fraud has reared its ugly head and it’s time to get it under control
To prevent and detect dealership fraud, you need to have multiple controls in place working together. Some dealers argue that the cost of putting these controls in place and monitoring them is not worth it however consider the following:
- Fraud now involves big dollars which comes right off your bottom line
- Recovery of assets is unlikely and there is damage to reputation/morale
- Using a data mining platform is a cost-effective way to combat fraud which is especially beneficial when the cost of doing business is high.
What dealers need to do now:
- Conduct a fraud review – “inspect what you expect” – controls need to work like they are supposed to
- Review what you get at month-end – prevention is key
- Set up a data mining platform – your DMS has everything you need
- Set up a hotline – most frauds are uncovered from an anonymous tip
- Review dealership security
If you suspect you may have fraud or want to discuss the simple measures above to prevent fraud, reach out to Maya Sutanto and the Pitcher Motor Industry Services team
