What is a Contract Audit?
Businesses run on contracts. Whether it’s a straight-forward service agreement or a high-stake acquisition, contracts underpin many of the decisions and movements of a company or law firm. So it’s important to make sure that every party complies with all of their contractual regulations. And that’s where a contract audit comes in.
Contract audits are internal assessments of contracts that check key provisions or regulations to make sure they are understood and followed by all parties. Contractual audits also verify and evaluate current policies, systems and controls to ensure they are up-to-date and accurate. This may involve analysing and verifying logs, accounts and transactions.
Contract auditing is typically carried out post-signature, rather than on pre-signature contracts, and usually includes multiple contracts; similar to a project review. They are also completed across the business - they may focus on a specific area or can look at multiple departments at once. They should be a regular occurrence in any organisation.
Contract audits are very commonly used for maintenance and construction contracts, and are frequent in government entities.
Types of Contract Audit
The size and type of these contract audits will depend on the purpose and the desired outcomes. There are many different styles of audit, often with interchangeable names depending on the location and industry.
Here we have highlighted a few of the most common contractual audits:
- Scheme audits - typically funded by capital expenditures
- Contract compliance audits - a legal audit carried out to ensure that signed contractual terms are being honoured by all parties
- Defective pricing audits - used to determine the accuracy of costs or pricing and identify whether the business has been overcharged for a product or service
- Clause audits - carried out to identify any incorrect terms and clauses caused by changes to the business policies or the economic environment
Contract audits can also be divided into ‘reactive’ and ‘proactive’. Those that are completed reactively are related to specific organisational requirements, problems or events.
Differences Between Contract Audits and Contract Reviews
and contract audits are similar processes, and across different legal circles, the phrases are sometimes used synonymously. However, there are a few key differences between the two methods.
Firstly, a contract audit is typically only completed on a signed contract, whereas a contract review can be carried out on both pre- and post-signature contracts. Usually, this is because a contract audit is used to determine whether the terms and conditions are being met by both parties after an agreement has been reached.
Unlike a contract audit, a contract review can also be used in the negotiation process: making sure parties only agree to terms that fit with their company policies and positions. They are also often used to identify outdated or incorrect clauses caused by a change in the business or economy, and are carried out to flag any legal risks (this is known as a red flag review).
Contract reviews can be completed on individual or multiple contracts, whereas a contract audit involves multiple documents and usually is kept as an internal process.
Why Should You Audit Your Business’ Contracts?
Contract audits are vital to any business and should be carried out frequently to ensure that an organisation’s contractual processes are controlled. Highlighted below are just some of the benefits your company could gain from regular contractual audits.
Control and Recover Your Costs
By auditing your contracts, you can ensure that payments and costs are verified and that your business isn’t over-paying what was agreed. Not only does this improve your cash flow, but it prevents any future monetary errors, leading to significant savings and an increased financial performance in the long-run.
It is easy for small mistakes to be made, leading to inaccurate billing, but these mistakes could add up and significantly impact the finances of any company.
Improve Processes and Increase Contract Quality
Through the regular examination of policies, systems and controls, areas of non-compliance and outdated processes can be identified and corrected. As these findings and solutions are implemented, fewer problems should appear in future audits; particularly around non-compliance. This then reduces the likelihood of any mistakes or inefficiency causing lasting damage (both financially and reputationally) to the business.
By carrying out internal contract audits, it also ensures that the legal team has a thorough knowledge of the business’ contracts, and so contract management becomes quicker and more effective. Additionally, with this updated information, future contracts can be drafted at a higher quality and with more clarity; ensuring that the parties’ requirements are always relevant and beneficial for the organisation.
Prevent Fraudulent Activity
Contract audits prevent businesses from overpaying on services and products, and identifies any fraudulent activity (if it exists). Detecting these problems early-on minimises the impact felt on the organisation and reduces the likelihood of encountering legislative problems in the future. Regularly auditing contracts thoroughly also helps to deter any dishonest activities and keeps terms and conditions out of grey areas.
Effectively Manage Risk
Using a contractual audit, risk (this could include financial, reputational or legal risks) can be identified in advance, meaning that an organisation can prepare for any outcome. Even if the terms or clauses causing the risk cannot be changed immediately, having the information means that organisations are fully aware of the possibility and can reduce their liabilities, avoiding any long-term, irreversible damage.
Create Better Business Relationships
When examining customer-focused agreements, contract audits are there to ensure that the required product or service was delivered correctly and that all financial obligations were completed. By continually monitoring these contracts and the parties’ requirements, the business can avoid under-delivering, and develop a better and more trusting relationship with their customers.
When a contract audit is completed collaboratively, transparency between the organisations is increased dramatically and problems can be fixed by all involved. This generates a more personal relationship across the board and helps to improve future agreements, providing benefits (potentially even financial ones) to each party.
How to Get More From Your Contract Audits
To get the most from your business’ contract audits, it’s important that you consider several factors before you start. If they are not considered, important findings could be missed, which might have detrimental effects on the organisation.
What Are Your Objectives?
Firstly, it is vital to work out what you want objectives you want to hit from the contract audit. They need to be clear and upfront to direct the course of the audit and to make sure that you generate the relevant findings.
Ideally, contract audit objectives should cover known areas of potential non-compliance and exposure. And to ensure all parties are comfortable with the direction and the outcomes of the audit, stakeholders should also be consulted.
How Extensive is Your Contract Audit? - Scope and Timing
Secondly, look at whether you need to audit every part of each contract or if you are only looking at specific areas. Additionally, are you examining every contract or are there certain batches or types that can be ignored? This will impact significantly on how long the project will take and how much resource is required, something that also increases or decreases the cost of the process.
It may be that you don’t have enough resources internally to complete the contract audit quickly and efficiently, meaning that an additional consultant or firm may be required to help. This adds to the cost, so is something that needs to be planned for. If you are going to complete the audit yourself and you have a lot of contracts to get through, it may help you work more effectively if you break them into batches (potentially by type or by area).
Additionally, a contract audit should be completed when the legal team has enough capacity to cope with a potentially long process or any repercussions from the outcomes. If there are also process and system changes, the availability of other business areas also needs to be considered.
Define Contract Audit Roles and Create Your Team
Whether you decide to include an external party or just keep it internal, it is important to distinctly define tasks and roles so that work isn’t duplicated or missed. This is also vital to the security of the audit - you will be dealing with a lot of confidential items and team members need to have the correct set of permissions.
Can Legal Tech Help You With Contract Audits?
The short answer is yes, especially if you find one that works alongside your team and systems. However, it is important to scope out the right technology for you.
Using a solution like Summize, contract audits can be made easy. With a user-friendly contract management system, legal teams can store and analyse their contracts at the click of a button. The instant summaries created for each contract allow users to view every clause and manage legal risk effectively. And business users can be added to allow other colleagues or shareholders to immediately view their contracts and your team’s advice.And that’s Summize’s ultimate guide to contract audits!
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