IFraud continues to be a costly threat in construction. According to the Association of Certified Fraud Examiners (ACFE), the construction industry ranks fourth highest in median fraud losses per case across all industries. With complex projects, multiple contractors, and large cash flows, it’s no surprise construction companies are a frequent target. 

But what makes this industry so vulnerable—and what can you do to protect your business? 

In this article, we’ll explore: 

• Why construction is a high-risk industry for fraud 

• The most common fraud schemes targeting construction businesses 

• Practical internal controls and best practices to help you prevent financial loss 

Whether you’re a general contractor, subcontractor, or construction firm executive, understanding how and why fraud occurs is the first step to preventing it. Let’s start by breaking down the factors that make the construction industry a breeding ground for fraud. 

The Construction Industry: A Breeding Ground for Fraud 

Why is construction such a high fraud risk industry? There are three main reasons: the need for many separate businesses to work together on one central project, high-value transactions, and project-based work. 

Separate Businesses Working Together on One Central Project 

Construction projects often involve the combined work of multiple subcontractors, suppliers, and vendors. This means tools, equipment, and other assets are stored in common work areas, making it difficult to track ownership of individual assets. With so many workers coming and going, it becomes much easier for internal theft to go unnoticed. Lack of oversight and missing security processes between contractors further increases the risk of stolen property or materials. Suggestions for controls to deter asset misappropriation or theft will be mentioned in a later section.  

High Value Transactions 

Beyond physical assets, construction companies are frequently invoiced by their subcontractors. If one central employee is not responsible for processing invoices, employees won’t become familiar with their “regular” subcontractors. This can leave an open door for invoice fraud, also known as billing schemes. Essentially, a bad actor can send an invoice to a construction business pretending to be a subcontractor in order to receive pay for work they never performed. Accounts payable processes and controls are necessary to prevent this particular type of fraud. 

Project-Based Work Requiring Expensive Assets  

Construction companies own expensive assets ranging from heavy machinery to costly building materials like wood and metals. These assets command high resale prices, making construction sites a prime target for external theft.  

For external bad actors, physical security equipment should be implemented to ensure external thieves are detected promptly and can be reported to law enforcement.  

Why People Target Construction Businesses to Commit Fraud 

Three factors influence employees to commit construction fraud: motivation, rationalization, and opportunity. When construction workers feel a strain on their finances, both the motivation and rationalization to commit fraud is realized. Because the construction industry is sensitive to external pressures, there are times when a large population of construction workers may feel strain at the same time, leading to a rise in fraud cases.  

One such example was during the COVID-19 epidemic. Construction projects slowed, and when companies began to feel financially strained as a result, layoffs and business closures impacted the industry.  

Two well-known internal fraud opportunities include uncontrolled jobsites left open to stolen equipment and vendors offering kickbacks to project managers. However, like any other organization, construction companies are victims of fraud schemes involving asset misappropriation, billing, corruption, check tampering, and payroll.  

Construction businesses can help reduce the pressure on employees who may be struggling by offering confidential programs that provide support when needed. These may include addiction recovery resources, professional growth and development opportunities, and employee assistance programs. It’s also important for management to stay attuned to employee needs and offer support whenever possible. 

Furthermore, internal controls assist companies like yours in preventing fraud opportunities from presenting themselves. Below are some best practices in internal controls for construction companies. 

Internal Controls for Fraud Prevention 

There are four main types of fraud that commonly affect the construction industry: cash controls, subcontractor and supplier controls, jobsite controls, and payroll controls.  

Cash Controls 

Cash controls are any internal controls involving cash flow management. Cash controls often include accounts payable and receivable processes. Below are fraud prevention safeguards related to cash management. 

• Proper approval of invoices 

• Dual signatures on checks 

• Only certain personnel are authorized to sign checks 

• The individual who signs checks is not allowed to generate checks (aka segregation of duties) 

• Use of a lock box for customer payments 

• The individual billing customers isn’t allowed to receive or record customer payments 

• Use of a positive pay verification system at your bank 

Subcontractor and Supplier Controls 

Subcontractor controls are those that regulate processes related to outside service providers that assist you on projects. Supplier controls, on the other hand, involve processes related to product vendors. Listed below are best practices to prevent fraud related to your subcontractors and suppliers.  

• Payments should be compared to original contract amounts 

• Original contract costs should be compared to revised contract costs on a monthly basis 

• Monitor subcontractor/supplier bidding process 

Jobsite Controls 

Jobsite controls are processes that keep the fixable jobsite and related assets secure, for example:  

• Use of security cameras 

• Comparison of purchased material quantities to original estimates (inventory checks) 

Payroll Controls 

Payroll controls keep processes related to paying your employees secure and accurate. Payroll fraud is a very prevalent tactic used by scammers across industries, not just construction. We recommend these controls to many of our clients to keep payroll fraud (aka ghost employees) from impacting their businesses.  

• Report jobsite labor daily using an electronic sign-in/out system 

• Use of direct deposit 

• Reconciliation of the payroll bank account by someone outside of the payroll department 

• Surprise jobsite visits on payday to verify employees receiving payroll checks are not fictitious 

If you have questions about how to implement internal controls within your construction business to avoid financial losses, consider an internal control risk assessment. We identify vulnerabilities and red flags along with solutions to protect these fraud opportunity areas.  

Also, if you believe you’ve been a victim of fraud, you can talk to an advisor about a fraud examination to identify suspicious activity. Reach out to one of our advisors using the button below.