The Ultimate Guide to a Contract Compliance Audit Program
Guide
Everything You Need to Know about Contract Compliance Audit Programs
Table of Contents
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What is a Contract Compliance Audit?
The central goal of a contract compliance audit is simple: to get the value you worked so hard to negotiate.
Sounds straightforward enough, but there are often many hoops procurement and finance teams need to jump through in order to get there. Although contract terms and associated payments are the primary components of a contract compliance audit program, there are many factors at play that impact both of those pieces. Factors like…
Why are payment errors occurring?
Does the root cause lie with the procurement team, their suppliers, or the framing of the contracts themselves?
What do procurement teams need to do to ensure those errors don’t slip through the cracks again?
How do teams retrieve erroneous payments from suppliers without damaging those critical relationships?
That’s a lot for procurement and finance teams to keep up with. And without accurate measurement mechanisms, proactive communication, centralized contract governance, and a realistic process to do it all, it’s nearly impossible to prevent financial leakage from contract non-compliance.
Contract compliance audit programs can help teams recover lost funds, patch up leaky processes and action root causes of payment errors, and nurture critical supplier relationships. And when they do it right, the findings from one audit extend much further than one supplier: they can inform the management of the team’s entire supplier base.
When Do You Need A Contract Compliance Audit? (Reasons for a Contract Compliance Audit)
Contracts can be a major source of financial loss due to the lack of visibility most procurement and finance teams have once supplier agreements are in motion. The person who negotiated the contract and the person executing the contract are rarely the same person. Only 60% of organizations define roles in contract responsibility. The gap between what’s supposed to be paid and delivered vs. what’s actually being paid and delivered is where contract compliance errors occur.
There are many signs or reasons a procurement team would seek a contract compliance audit, and not all of them are obviously linked to financial loss.
Prevent Erroneous Payments
The primary and most obvious reason for a contract compliance audit is to remedy the financial costs of non-compliance / payment errors, when contract agreements don’t line up with execution. Again, since even that is usually unclear to the parties involved, incorrect payments slip through the cracks all the time.
Are suppliers delivering what they promised? Is your organization getting what you’ve paid for? These are questions many teams can’t answer without a contract compliance audit.
Improve Contract Execution
Contracts are complex, lengthy legal documents that can be extremely hard to comprehend. They’re riddled with industry jargon, legal terms, and blurred lines of enforcement. 90% of professionals find contracts “impossible” to understand. To complicate things further, the person who negotiated the contract is almost never the same person as the one who’s executing it.
A lack of standardization and communication makes it challenging to ensure contracts are being adhered to…especially when there isn’t anyone assigned to the task of doing so.
Enhance Financial Visibility and Measurement
Accurately forecasting costs is essential for organizations to achieve their margin and profitability goals. If supplier billing errors pass through undetected, teams’ costs may increase unbeknownst to them…leading to an incorrect reflection of their payments and, therefore, margins.
When there’s a lack of transparency into contracts and their execution, finance teams are likely to be surprised by erroneous transactions. Some examples of instances in which teams lack transparency into transactions include paying for a 10 hour service call that only took 5 hours, or paying for a 20% markup when the contract only allowed for 15%.
As long as a payment looks reasonable, teams have no reason to look into it any further – but without that insight, it’s impossible to know how many small errors (or big ones) are seeping through undetected.
A contract compliance audit provides that insight through further, deeper evaluation of payments and whether they reflect what’s outlined in the contract terms. By scrutinizing payments on an individual basis and comparing them to contract terms, contract compliance audit partners give finance teams a clear perspective on their transactions to guide their financial reporting.
Reduce Friction in Supplier Relationships
Suppliers are critical players in complex business ecosystems. When you set out to correct and recover overpayments, it’s important to reduce friction from the process and maintain that relationship. When payments are involved, there can be a heightened level of sensitivity at play.
70% of friction points within supplier relationships occur before a contract is even signed. Many teams avoid the matter altogether to ensure they don’t put the relationship at risk; however, not asking for that money back at all means a 100% chance of financial loss. That’s why contract compliance audit programs need to be handled professionally, and audit partners must ensure they’re doing right by the procurement team in all communications.
Prepare for RFPs
If your organization ever requires an external product or service, you’ll need to shop around before finding a supplier who checks all your boxes. And to do that, you’ll need to write a few requests for proposals (RFPs). The problem with RFPs is that a lot of the time, there’s a great deal of room for miscommunication: miscommunication about what it is you need / expect from your suppliers, the scope of work, the way you’ll compensate them, and more.
Contract compliance audits can help procurement teams proactively identify what they’re missing in current supplier agreements, so that they can make better decisions about future ones. By identifying gaps and unclear contract language, procurement teams can make smarter decisions and pursue more beneficial suppliers.
Benefits of a Contract Compliance Audit Program
Though the principal benefit of a contract compliance audit is to recover the money you’re rightly owed from suppliers, there are many benefits that result from auditing contract compliance.
Improve Cash Flow and Margins
To uphold key supplier relationships, finance teams may avoid checking and recovering from erroneous payments. Even when teams do choose to pursue recovery, if they wait too long to do so, contracts may time out or suppliers may lose crucial documentation required to pay them back.
When so much time and energy is spent negotiating contracts, it’s crucial that they’re properly adhered to. By conducting regular, timely contract compliance audits, teams can uncover where they’ve overspent or incorrectly paid suppliers and ensure they’ve gotten what they’ve paid for (AND agreed to).
Gain Visibility and Measure Supplier Performance
Though the execution of contractual agreements can often go unchecked and unmonitored, contract compliance audits provide procurement and finance teams with the visibility to precisely measure supplier performance.
Without visibility, it can be challenging to attribute errors to their rightful cause – and therefore challenging to resolve them. For example, if indirect costs are higher than anticipated, there could be a number of reasons for that. It might not be because you didn't negotiate the right terms, but because you aren't monitoring and ensuring vendors comply with the contractual terms.
With a knowledge of supplier weaknesses and compliance gaps, procurement teams can take action on how to manage the contract moving forward, as well as contracts with other suppliers.
Enhance Supplier Contracts
Findings from one contract are rarely unique to that contract alone. With the context of one contract’s weaknesses and areas of improvement, teams can go forward and build stronger contracts in the future with their existing or new suppliers.
In some cases, teams can even action their findings immediately and make midterm improvements to existing contracts. With the benchmarks of cost and performance of their suppliers, procurement teams gain a basis of comparison as they move forward and evaluate contracts years down the line.
Optimize Contract ROI with Minimal Time Investment
The reason many companies struggle with contract compliance isn’t because it’s a low priority: it’s because their team is already busy with their existing duties and can’t afford to take on another daunting task.
The longer a procurement team waits to check in on their contracts to ensure they’re getting everything they’re paying for, the worse the damages and overpayments can become. However, the small time investment in a contract compliance audit program can correct months or even years of overpayments, creating tremendous value.
Dispute resolution costs businesses an average of $870 billion each year. On the other hand, the average ROI on a contract compliance audit is up to 4-6 times, according to Beroe. When there’s so much value on the table, the ROI of contract compliance can’t be overstated.
Reduce Contract Risk
Contract compliance audits help teams recoup the funds they’ve erroneously paid while maintaining the security of strong supplier relationships. When teams can see the blindspots in their supplier contracts, they’re able to assess where there’s been non-compliance, unintended supplier profits, and diminished margins.
By identifying and closing these gaps, procurement and finance teams avoid potential breaches of contracts and their consequences, such as legal action or a hit to their supplier relationships.
Continuous Improvement in Procurement
Contract compliance audits can drive both immediate and long-term improvement in procurement processes and profitability. By conducting regular contract compliance audits, teams get more than one single recovery. They get insight into their internal processes and the weaknesses in their supplier agreements so they can continue to improve.
The growth teams see after conducting a contract compliance audit is both internal and external as they gain a better understanding of where their firm stands and how they can better execute contracts to enhance supplier performance.
How to Set Up a Contract Compliance Audit Program
When conducting contract compliance audits, it’s crucial to seek a partner that prioritizes continuous improvement and protecting supplier relationships. That’s why in the audit process, visibility, customization to your unique environment, and partnership are key.
Contract Compliance Audit Program Step 1: Establish Audit Goals
Contract compliance audits can have a number of benefits – but it’s important to first establish your goals for the audit program. Is the primary objective to recover overpayments, clean up and improve contract language, or evaluate supplier performance?
One or all of these might be goals of the audit program, but it’s important for the audit partner to understand why the organization is seeking a contract compliance audit in order to tailor the approach appropriately. Additionally, if there are any company policies or supplier nuances the audit partner should be aware of, these should be taken into consideration as well.
Contract Compliance Audit Program Step 2: Identify Suppliers to Audit
Big companies often have dozens of business-critical suppliers. How do they determine which ones should be audited? Procurement and finance teams can get to the bottom of this by taking a risk-based assessment approach. Factors to consider when determining which suppliers to audit include:
The annual spend on a given supplier
The complexity of supplier contracts
The importance of the supplier’s product or service to the organization
Previous concerns within their contracts
How much transparency you have into vendor costs
In addition to their risk profiles, there are also the less quantifiable metrics that make a supplier a great candidate to audit. Procurement and finance teams have the most hands-on experience with suppliers, whether they were the ones who negotiated or are currently the ones executing the contract, and their input is key.
It might feel overwhelming trying to determine which suppliers will be the most valuable to audit. But the good news is, with the right contract compliance audit partner, auditing even just one supplier will open the door to improvement within other supplier relationships.
Contract Compliance Audit Program Step 3: Tailor Strategy to Specific Suppliers
With background information such as audit goals and the suppliers involved, the auditors then create a tailored audit plan specific to the supplier and the company’s needs. Auditors begin to review contracts and build risk assessments that are the basis for each audit plan. The risk assessment highlights the potential areas of risk and the appropriate audit steps required to validate the accuracy of billings.
Contract compliance audits can be sensitive matters because they involve external parties that are supremely important to the health of the business. If the audit partner will be communicating with the suppliers on the organization’s behalf, they must get all communications approved before proceeding and tread lightly around these delicate relationships.
Contract Compliance Audit Program Step 4: Deliver Audit Report
At the close of a contract compliance audit, procurement and finance teams will be presented with the final audit report illuminating the audit team’s findings.
At the discretion of the organization seeking the audit, the audit partner will recoup any erroneous payments that were made to the involved suppliers. In addition, the audit partner will propose possible improvements within the contract and its execution as well as provide actionable recommendations for the future of their contracts.
Contract Compliance Audit Program Step 5: Enable Continuous Improvement
Armed with the knowledge of what makes an audit valuable (and how to make sure it’s executed that way), the procurement team can negotiate contracts in their best interest – INSTEAD of relying on recovery to retrieve the funds they should have never lost in the first place.
Finance teams gain accurate visibility into supplier performance, and the measurement capabilities to keep track of contract execution. Additionally, based on any loose ends that the team identified in their own internal processes, organizations can build a CULTURE of contract compliance – versus the tick-the-box mentality that they may have been trapped in before.
How FlexTecs Can Help You With Contract Compliance
For a contract compliance audit to be successful, you need a partner that prioritizes clarity and continuous improvement in all of your supplier agreements. That’s why FlexTecs does it differently than the other guys.
With a structured, contextualized, and tailored audit approach, we help you use findings from your most important, highest-risk suppliers to drive contract enhancements across ALL suppliers. We give you the visibility into their performance that you need to make smarter procurement decisions and fortify those supplier relationships – improving them instead of cutting your losses whenever there’s an erroneous payment or instance of non-compliance.
If you’re concerned about your margins and the profitability of your contracts, the performance of your suppliers, or the internal processes that guide the governance of your contracts, FlexTecs is here to help.
Want to get the contract terms you worked so hard to negotiate? You’ve come to the right place. Reach out today.