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What Is a Contract Compliance Audit?

The importance of auditing your business contracts
woman working with laptop in a meeting room.

Do you know what is in your contracts and if everyone is holding up their end of the deal? Is every party involved being compliant and following through on what was agreed? Unchecked, these blind spots become deeply problematic to your business.

The best way to resolve it: performing contracts compliance audits.

What is a contract compliance audit?

At its most basic, a contract compliance audit is a review of whether your contracts and their terms are being honored by all the parties who signed them. However, not all contract compliance audits are the same. The type and size of audit you perform depends on the exact purpose and scope.

The benefits of a contract compliance audit

Cost savings

You shouldn’t pay more than you agreed to in any contract. Verifying billing and the receipt of goods or services heads off stopping over-payments and, in turn, improving your cash flow.

Improved trust and business relations

Contract compliance audits increase transparency and trust between businesses. Performing collaborative audits and working with other companies to fix any issues – big or small – can establish trust with partners and build long-term relationships.

Improving your business

Contract compliance audits also allow organizations to learn, evolve and scale better. Their findings shed light on internal blind spots and offer a chance to improve internal processes. Over time, as these learnings are integrated into your business, audits turn up fewer problems related to organizational non-compliance, catching non-compliance before lasting damage occurs.

Reactive and proactive audits

The reasons to conduct a contract compliance audit can be reactive to specific business events, needs or concerns. For example:

  • New funding round
  • Large capital expenditure (new buildings, land, equipment, etc.)
  • Expansion into new markets
  • Merger or acquisition (M&A)
  • Significant structural change
  • Significant personnel change
  • Before bidding for a new service
  • Starting work with a new vendor
  • Terminating an existing vendor relationship
  • Auto-renewal of evergreen contracts
  • Specific party presents a certain risk

Contract compliance audits can also be proactive. For instance, an audit you perform routinely, let’s say, annually, and with a broad purpose, is proactive and acts mostly as a preventative measure — addressing potential issues before they become problems. Think of proactive contract compliance audits as regular health check ups on your business agreements.

Audit objectives

A better understanding of obligations and liabilities

A company not living up to its contractual obligations faces legal, financial and reputational risks. You need to know exactly what each of your contracts calls for and the potential risks involved.

Find areas of non-compliance

Non-compliance comes in big and small forms. More often than not, non-compliance happens in less obvious ways, such as late deliveries, over-billing or poor-quality goods. Over time, these issues can cause serious financial and reputational damage when you aren’t receiving what you should or are paying too much for it.

Audits can also highlight larger significant breaches of contracts that need to be addressed urgently before they seriously impact your business.

Billing accuracy

Inaccurate billing is rarely intentional. Instead, small mistakes can add up. An audit could take a deep dive into confirming invoice amounts and determining if you have overpaid.

A better understanding of your rights

What you do about non-compliance usually depends on what’s inside your contracts. You should know your options. Does the agreement call for arbitration? What are the provisions controlling litigation, including venue, choice of law, filing deadlines and damages provisions?

A better understanding of internal controls

How do you ensure a contract is being upheld? Are there steps in place to identify and rectify non-compliance, especially in its subtle forms?

Clear direction for improvement

There’s always room to improve how you manage contracts. Audits can offer data-driven guidance on upgrading internal processes and controls.

Starting your contract compliance audit

  1. Define objectives for the audit. Gather the stakeholders and talk it through. Ask what they want to know at the end of the audit process.
  2. Consider the timing of the audit. When is the most reasonable time to start? Consider hard deadlines in your business or industry.
  3. Consider the scope. Is this audit for your entire contract portfolio or only certain contracts? What specifics are you looking at? More importantly, what areas of exploration are you not including in the audit?
  4. Create the audit team. This can be internal or external, or a mix. A neutral third party can help, particularly if your company needs to review your entire portfolio, has never performed an audit before, or is dealing with decentralized storage.
  5. Define roles. Security during an audit is extremely important, and employees should have access only to what they need. Once you know who’s working on the audit, assign specific tasks and set their permissions.

Audit communications and security

If you had to focus on one thing to keep your audit productive and useful (and not a dumpster fire), it would be communication. For any contract compliance audit, communication is no easy feat.

Internal communications

With all communications surrounding a contract compliance audit, your employees should never feel like they are personally under investigation. The audit might be a busy time with all hands on deck, but it shouldn’t cause fear. Make sure the right communication strategy is in place to ensure unwanted (and unnecessary) anxiety does not occur. Internally, strong communication starts by defining and writing down the purpose, goals and scope of your audit. Communicate in writing, considerately and carefully, to everyone involved in an audit. Sounding alarm bells to various teams undermines an audit’s purpose and won’t help your business long-term.

External communications

Externally, good communication can make or break your business relationships. To aim for the former, notify every contract party that will be touched by the audit. Transparency sets the tone. Rather than assigning blame or raising suspicion, focus on collaboration and strengthening the relationship between you and the other party.

Another reason to communicate to external parties early: needing information, documentation and access that only they can provide.

Security and privacy concerns

Throughout this entire process, be mindful of other organizations’ security and privacy concerns. You could face barriers if a company doesn’t want to grant you full access. This is where your contractual rights come in. Is there an audit clause in your contract? No? Don’t panic. That doesn’t mean you don’t have the right to perform an audit.

If not addressed in your current agreement, be upfront with the other party about your process or suggest a neutral third-party to conduct the audit. A professional service can be a great option as they will be mindful of all parties’ security and privacy concerns.

Final reports

Your final reports should reflect the initial purpose of the audit. They should include clear, accurate data and conclusions. Fundamentally, they should address instances of non-compliance. The report should also outline how you’re addressing remediation with the other parties involved.

With each audit, use the results to improve your internal processes. If the audit finds no problems, congratulations! If it does, it’s your responsibility to resolve them and find a way to prevent future issues.

Wrap up

To head off trouble from reoccurring in your contracts, it’s important to see the results of contract compliance audits as one part of the whole. Your business contracts are best served by taking a comprehensive approach to contract management. Developing and streamlining processes for templates, negotiations, employee permissions, tracking and storage is the start. Otherwise, you might not like what your audits turn up.

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