Manufacturing Sector and Fraud Risks Post COVID-19

Recent Pandemic has rocked the global economy badly specially the manufacturing sector. As COVID-19 was detected in India in early March 2020 lockdown was initiated in the fourth week of March for 3 weeks and most of the non-essential manufacturing units were asked to stop producing and take strict measures before re-opening their units, which affected the sector badly in which workers lost their lively hood and growing financial burden pressurised the sector further to downsize and look at other alternatives to stay afloat and people associated with them.

Unfortunately, post COVID-19 the sector is facing its own set of challenges which has impacted growth for the sector and has unforeseen challenges. Conventionally, one of major concern for this sector has been managing squeezed margins and the problem further gets aggravated with incidents of reported fraud, which further swallow profits of the sector and affects their profitability and long-term growth. Before mentioning or initiating a fraud investigation one should understand the sector/products manufactured, geography, manpower and local landscape.

Manufacturing sector has been an integral part of Indian growth story since its independence in 1947, as Government of India made changes to its policies over the years, to which affect “Made In India” was promoted in 2014 by our Prime Minister Shri Narendra Modi Ji. As manufacturing has multiple sub-sectors such as automotive, engineering, pharmaceutical which are driving employment and are contributing towards our GDP.

According to ACFE latest report released in 2020 “Report to the Nations” most common occupational fraud schemes in manufacturing sector is “corruption” which accounts for 50% of fraud and accounts for an average of $198,000[1] median loss to its principal in this sector. Inevitably, fraud risks not only hurt bottom lines but possess other serious implications such as reputational and regulatory risks. The outcome of which terrifies organisations and its management as it drains resources and hurts investors trust, shareholders investments, employee’smorale, and consumer confidence. Mitigating and preventing fraud in manufacturing sector is therefore important as it can prevent potential losses, strengthen business, boosts morale and gainsand holds its competitive advantage over its competition.

How vulnerable is Indian manufacturing sector?

Indian Manufacturers are vulnerable to fraud due to multiple reasons such as high inventory (raw material, unfinished and finished material), making it susceptible for inventory fraud schemes and non-cash theft. Apart from that bribery and corruption from third-party vendors and conventional fraud methods such as falsification in books of accounts/financial statements continue to thrive. Although the sector is gearing up to draw the benefits of technology and automation, fraud risks still thrive in manufacturing sector. Here are few unique traits of the sector which makes them vulnerable to fraud:

  • Unmonitored supply chains, which are a potential loophole for fraud to occur. Lengthy and complex supply chains involve multiple physical facilities and several interrelated components, which breed potential risks at various stages – from sourcing of raw material until the final product reaches the consumer.
  • Multiple third-parties dominate these sub-sectors, such as pharmaceutical, automotive, textiles and aerospace and any unethical actions of one third-party directly effects entire chain of organisation and employees.
  • Most of the manufacturers are struggling to restart their businesses as they are unsure of the raw material and consistency of its supply. As these vendors are struggling to get trained man-power or other raw material to provide the principal. Moreover, underlying assets in form of inventory carries a high risk of fraud and theft.
  • Other key risk which the sector is currently facing is government touchpoints for obtaining or revalidating their licences and other permits to restart their businesses and concomitant risk of bribery and corruption looms large.
  • Other several regular deals which are often have a low value are susceptible to specific fraud schemes which hurt the sentiments of the sector.

Some of the other possible red flags of fraud in manufacturing sector include:

  • Aberrant increase in billing volume, receiving inflated invoices or several payments made to such vendors without any subsequent services provided.
  • Evidentcorrelations and connections between company employees and third-party vendors involved in procurement or purchasing of material/goods or involved in distribution of crucial contracts.
  • Disproportionate contraction in inventory levels:
  • Vendors who are consistently being awarded valuable contracts despite their mediocre performance, absence of any specific advantage over his competition
  • Unexpected and unjustified rise in consumer grievances which can be also attributed to other reasons such as fake/similar look-alike products
  • Compensation or gratification payments offered to employees/agents/distributors on account of redirecting order to competition.

How can we fight fraud in the manufacturing sector?

Initiate fraud risk management programme or fraud risk assessments:

Address crucial exposures in manufacturing sector while composing fraud risk policy. One should understand the product offered and then consider risks associated with them which can be associated to third-parties or counterparties, non-cash fraud and conflict of interest. Another key concern which should be addressed is fraudulent disbursements, which are widespread and can be checked with suitable segregation of duties within departments and key employees.

Strong Internal controls:

Every manufacturing sector relies on its internal controls to survive; strong internal controls are essential to prevent fraud and timely detection. Internal controls ensure departments keep appropriate documentation which helps in maintaining crucial paper trail while monitoring various processes. Keeping controls in place also addresses concerns arising from archaic cash disbursements issues and encourage electronic modes of payments to employees, vendors and other third parties. Consider including whistleblower policies and internal due diligence for reporting unethical behaviour, code of conduct, etc. For any internal control to be effective, periodic reviews and monitoring are crucial.

Strengthen and leverage technology:

Companies who have advance technological advantage have seen that technology has become their first line of defence for their businesses to detect and prevent fraud. Using sophisticated software and IT systems, analysis of voluminous data helps them detect potential anomalies and data monitoring which signifies reduction in losses due to fraud.

Conclusion:

Manufacturing sector would continue to be exposed to occupational fraud which might hinder its growth. However, if sector can introduce robust Fraud Risk Management policies and initiate periodic Fraud Risk Assessments which can identify and mitigate these threats. Apart from that it is also important for manufacturing sector to diligently onboard an employee or a third party as that will help them making a informed decision. However, frauds will continue to grow, and fraudsters will devise new methods to defraud companies, initiating and implementing tailored anti-fraud controls can significantly reduce or can even eliminate threats of frauds.

Disclaimer: This content is meant for information only and should not be considered as an advice or opinion, or otherwise. AKGVG & Associates does not intend to advertise its services through this.

Posted by: Hurrmeet SG Vohra

AKGVG & Associates

[1] 1 USD equals 75.75 INR, in total 14.96 million INR

Leave a Reply

Your email address will not be published. Required fields are marked *