If you want to ensure your contracts continue to operate effectively, deliver value for your organization, and protect company interests, it’s essential to perform regular audits.
However, these can be complicated and often involve a range of processes, from reviewing relevant documents to inspecting transaction records.
If you’re new to contract auditing or just want to get on top of this crucial process, read on to learn everything you need to know.
In this article, we’ll explain what contract auditing is, why it’s important, the different types, and how to perform one.
Key takeaways:
- Contract audits are designed to ensure that every party involved are honouring the terms and upholding the agreement.
- Auditing your contracts can flag up potentially fraudulent activity or financial irregularities and reduce your company’s exposure to risk.
- There are several types of audits and each of them serve slightly different purposes.
- Effective contract management software can help your company with the audit process.
What is contract auditing?
Contract auditing is the process of ensuring contract compliance across your organization.
Through contract audits, you can verify that existing contracts are accurate and ensure that they’re being effectively performed.
Ultimately, the goal of a contract audit is to confirm that you and the other parties involved are meeting your deliverables and that the standards in the contract are being upheld.
These checks can differ in scale depending on the needs of your organization.
For example, you might want to perform an audit of your entire portfolio or focus on one individual contract.
One of the processes involved in contract auditing is inspecting records, such as transaction and operation logs, as well as relevant account books.
These checks allow you to ensure that any contractual billing and delivery requirements are being met.
They also reduce the risk of fraudulent activity that might be negatively impacting your business.
Contract audits should be used to examine the processes and operations related to a contract as well as any physical documents.
This means you should check whether policies are up-to-date and effective and that every part of the business operation is compliant with your contract.
The importance of auditing contracts
If you’re in charge of a business, you should have no doubt about why contracts are important. Regardless of your industry, they protect your interests and reduce risks by clearly setting out the rights and obligations of each party.
This is why it’s so important to audit your contracts: you must make sure they’re working as they’re supposed to.
Here are some of the main reasons why auditing contracts is essential.
1. Verifying compliance
A contract isn’t worth the paper it’s written on if the signatories aren’t following the obligations, terms, and conditions outlined in it.
Fortunately, contract auditing allows you to check that your organization’s policies and processes comply with your contractual obligations, meaning accidental breaches are unlikely.
This works the other way around, too, allowing you to check that the parties you’re contracting with are also complying with their ongoing obligations.
2. Reducing risk
Risk mitigation has to be one of the most significant upsides that come from a contract audit.
Auditing your contracts can alert you to any potentially fraudulent activity and reduce your company’s exposure to risk.
3. Cost and quality assurance
The close examination of financial records that comes with a contract audit will help you spot any financial irregularities — such as missed payments — so you can recover lost funds.
You’ll also be able to ensure that the provision of goods or services specified in your contract is in line with your quality assurance guidelines, thus protecting your brand’s reputation and helping you produce high-quality products for your clients.
Types of contract audits:
Now you know what contract audits are and why they’re important, you’re probably wondering how to start implementing audits in your organization.
If you don’t already have a contract auditing process, you’re leaving yourself exposed to the costs and risks that come with contract non-compliance.
However, contract auditing is not a one-size-fits-all exercise: there are many different types of audits, each serving slightly different purposes.
So, before you go any further, you’ll first have to decide which type of contract audit best suits the size, industry, and aims of your organization.
Clause audits
If you’re working with other organizations to deliver certain goods or services, contracts with clauses may be used, which specify what these goods and services are, as well as payment details and other variables.
Often, versions of the same contract will be used repeatedly to save time and effort at the negotiating table — but this approach can leave agreements outdated or not quite fit for purpose.
A clause contract audit analyzes your contracts line by line to make sure none of the individual clauses are out of date.
This might be a problem if you’ve recently changed your business policies.
For example, a contractual term requiring the signatory to use a certain software might become outdated if you update your company’s digital infrastructure.
Terms and clauses may also become unfit for purpose due to changes in the economic environment.
For instance, they might link some payments to interest rates that have changed since the contract was signed or refer to external organizations that have since ceased trading.
Scheme audits
While it’s important that every company can provide basic answers to a question like ‘What is contract management’, not all businesses are as clued up as they should be.
One industry where it’s imperative to understand the basics of contract management is construction, where scheme audits are common.
These are a type of contract audit that specifically analyzes the contracts used by maintenance or construction organizations.
This is important as the costs involved in these industries can be incredibly high, as well as being influenced by changes in energy prices and supply chains.
Without effective contract auditing, these external factors can leave companies liable for some very expensive payments.
As they’re so important, scheme audits are usually integrated into the day-to-day operations of maintenance and construction companies and are financed by capital expenditure.
Defective pricing
One of the fundamental drivers of a business’s success is managing costs.
This is why contract audits that check for defective pricing are important.
Setting out prices in a contract is crucial if you want to ensure certainty around payments — but it can also leave you vulnerable to negative changes in the economic environment.
Let’s say you agree to provide certain goods that require an energy-intensive production process.
While the payments you agreed to in the original contract may have allowed for a profitable operation at the time, changes to energy costs may mean those prices no longer cover your expenses.
Defective pricing auditing can also help make sure that you’re not overpaying for certain goods or services.
It usually looks at the pricing clauses in a contract as well as your wider financial records to ensure costs are kept under control and up to date.
Contract compliance
Audits that focus on changing payment clauses or looking for defective pricing are essentially financial operations, whereas compliance audits focus on the legalities.
After all, contracts are legally binding documents that require each party to follow the terms and conditions set out.
You’ll need to identify the specific policies and operations required by the contract before examining whether they’re being followed.
This can be a time-consuming and challenging exercise, requiring you to work across the entire organization and potentially liaise between different departments.
However, compliance audits are nonetheless essential to protect the integrity of your contracts and build trust between parties.
If you know everyone involved in the contract is following the requirements it sets out, you’ll be able to work together much more efficiently and effectively.
Contract management
The types of audits we’ve already highlighted are usually performed on specific contracts.
However, it’s also essential to ensure your organization has effective policies when it comes to managing its complete stable of contracts.
Without a functioning contract management system, losing track of these is easy.
This can result in contracts being lost rather than renewed when they reach the end of their lifecycle or certain terms and conditions not being met.
Ergo, an audit that examines your broader contract management policies is invaluable.
To perform a contract management audit, you’ll need access to your organization’s entire contract portfolio.
This will allow you to see how many contracts you’re bound by.
You’ll also want to see any software or policies the company uses to manage this.
Contract audit template example
If you’re looking for an example of a template, which you can use to submit proposals for a contract auditing service, this one from PandaDoc can help you.
How to audit your contract
Now that we’ve explored the different types of contract audits and seen an example template. Let’s look at the steps you need to take to perform an effective audit.
1. Define your aims and scope
It’s crucial to know exactly what you want to achieve from your contract audit before you begin.
If you aren’t clear on this, your audit will be unfocused and take more time and money than needed.
Consider the specific needs of your organization, and think about which type of contract audit will best suit your requirements.
If you already know there are elements of your operations that are potentially non-compliant, focus on these to start with.
You need to consider the resources you have at your disposal when deciding on your scope.
2. Choose your team
Performing a contract audit requires a team of skilled employees with a deep knowledge of your business and its operations, as well as the legal expertise to read hundreds of lines of legalese effectively.
If you feel you can’t find this team internally, consider outsourcing to an external team of contract auditors.
While this will increase costs, you can be sure they’ll have the necessary expertise.
3. Tick off a checklist
Once you know the scope of your audit and have assembled a team of auditors, you should prepare a checklist.
The items on this can be compiled together using an audit proposal template so everyone in your organization knows how and why you’re performing the audit.
This checklist will depend on your specific needs but should include checks on payments and amendments as a minimum.
Robust contract audit templates from PandaDoc
You should now recognize how vital contract auditing is for an organization.
It’s an essential component in safeguarding the effectiveness of your contracts by reducing risks, ensuring compliance, and managing costs.
It’s also an opportunity to reduce the chances of poor-quality services or goods.
Without regular contract audits, you can’t be sure a contract’s signatories are fully compliant with its terms, conditions, and obligations; analyzing financial records and business policies will mean your contracts are actually being followed.
This can also protect your organization from any penalties that come from non-compliance.
While you should be able to use the tips in this article to work out which type of contract audit best suits your organization, auditing can still be a daunting task.
That’s why the contract audit templates from PandaDoc are so helpful.
Rather than having to start from scratch, PandaDoc’s contract management software can be used to streamline all the operations related to your portfolio of contracts.
You can use templates and prepare proposals to make sure your contract auditing is as robust as possible.
Why not start auditing your contracts today with the help of PandaDoc?
