You might think that once a business contract is signed, that’s the end of the matter. But it shouldn’t be a one-and-done process.
If you don’t look back at the details periodically, you can’t be sure that the terms are being met. If your business handles multiple contracts, you may not even remember exactly what those terms are. Contracts may also need updating when there are changes to prices or legal requirements.
A contract audit will help you pick up potential problems, such as unclear language or non-compliance, before they lead to a delay or dispute. It’s also a chance to review the processes you use to manage contracts.
Contract audits are time-consuming, especially if your organisation uses manual processes. Some businesses outsource this to a specialist firm, but we’re going to show you how to perform the process in-house.
In this post, we’ll look at the objectives of a contract audit and take you through the best practices and audit procedures to guarantee clarity and compliance.
Importance of conducting a detailed contract audit
A contract audit is a detailed health check that evaluates and verifies your existing current policies, systems, and controls. It helps you make sure that the information contained in your contracts is accurate and that all parties can understand and follow the agreed processes.
One of the key benefits is that the audit will highlight potential non-compliance or contract breaches, which could damage your business’s reputation and cost you money. You’ll also be able to spot inaccuracies in financial documents and find opportunities for cost savings.
For example, you can make sure that all payments are verified and that you’re not overpaying your business partners. This will improve your cash flow and overall financial performance. On the flipside, a contract audit shows if you’re underpaying your suppliers or failing to deliver on what was agreed. By ironing out these issues, you can build better working relationships.
Contract audits may be reactive or proactive. A reactive audit is carried out when a specific problem or requirement arises, while a proactive audit is performed at regular intervals to check that everything is in order. This helps you identify risks in advance, prepare for any scenario, and streamline outdated processes.
There are many different types of audits, such as contract compliance audits to make sure that signed contractual terms are being honoured by all parties and clause audits that check for incorrect terms and clauses caused by changes to business policies or the economic environment.
Contract audits should not be confused with contract reviews. In most cases, you perform an audit only on a signed contract, but reviews are for both pre-and post-signature contracts.
How to conduct a thorough contract audit
So, now we understand the importance of how you conduct a smart contract audit. Start by setting your objectives for the audit, and then follow the steps of the audit process as shown below.
Gather relevant contract documentation
Contract audits usually focus on a specific area or department, so the first step is to determine the area of coverage and the scope of the audit. Make sure you’re only checking relevant documents. Otherwise, you’ll confuse things and give yourself extra work.
You’ll be looking at multiple documents, so make sure you have them all to hand. Contracts and supporting documentation may be stored in many different places, especially if your company still uses physical paperwork. It’s better to centralise and manage your files with an ERP accounting system that brings together data from across the business.
Determine key stakeholders in the audit process
Contract audits aren’t only for legal teams—they tend to involve a range of stakeholders. For instance, if you’re focusing on cost irregularities, you’ll be working with the financial department. You may also perform the audit in collaboration with the other party in the contract, typically another business.
But whether the audit is internal or involves an external party, every stakeholder needs to have clear roles and responsibilities so that tasks don’t get duplicated or overlooked. Always be transparent about your aims and objectives, and make sure team members have the correct security permissions for auditing confidential files.
Review contractual obligations and milestones
Part of the audit will involve reviewing the obligations outlined in a contract to check that these are being met on both sides. This could cover anything from payment dates to agreements on the protection of intellectual property assets.
A freelancer contract might stipulate the completion of 25 hours of work per week for your company. Or it may require your business to keep an investor updated at specific intervals when a project milestone is reached. If you find a discrepancy, you can highlight any areas that may need renegotiation or rewording.
Ensure compliance with applicable laws and regulations
You’ll also use the audit to make sure that your contracts are in line with relevant laws, regulations, and industry standards. By reviewing the various terms and conditions, you can check that the contracts are still legally binding and, therefore, enforceable.
When you find a potential area of non-compliance, you can make adjustments before it becomes a bigger problem. You’ll need to stay up-to-date on any changes to applicable laws and regulations. It’s also worth evaluating how you store and access documents, for compliance with data privacy laws.
Assess the quality and punctuality of deliverables
As well as checking that contractual obligations are accurate and up to date, you’ll also look at how well each side is delivering on those commitments. Has everyone done what they’re supposed to do by the agreed deadlines? Have both parties delivered the required level of quality and performance?
You can use key performance indicators (KPIs) to see if targets are being met. If they’re not, the audit also gives you the chance to find out why—and do something about it. For example, was there a delay caused by unclear terms in the contract?
Identify uncertainties or contradictions in the contractual language
One of the biggest causes of contractual problems is when the wording of the contract is unclear. It’s important that the audit looks closely at all terms and conditions to make sure there’s no ambiguity or contradiction and that everything is set out in plain, jargon-free language.
If you don’t pay attention to this stage, there may be grey areas in your agreements—which increases the risk of one party exploiting a loophole. You should also make it very clear what will happen in the event of a dispute.
Validate accuracy of invoices and financial documents
As well as the contract itself, you need to review the financial documents that go with it. Look at your financial statements and verify that all transactions are legitimate, and that they’re recorded accurately. Where a contract states the method and date of payments, check that these terms are adhered to.
You can keep track of invoices more easily with automated accounts payable solutions, which helps you to avoid late or duplicate payments. Make sure you update contracts to reflect any price changes from suppliers or contractors, and look for opportunities to negotiate better rates. In this way, contract audits have a positive impact on cost control and financial forecasting.
Evaluate contract renewal and termination processes
It’s vital that your renewal and termination processes are completely clear, so that there’s no room for disagreement. For example, do you offer an option for auto-renewal? If so, make sure that the other party has understood this and has formally opted in.
If your contracts don’t auto-renew, you’ll need to put workflows in place to avoid missing the expiration dates. Ideally, you want a contract management system that alerts you to contracts coming up for renewal. You can then examine these to identify any outstanding issues and renegotiate terms if necessary.
Create a comprehensive audit report and monitoring mechanisms
Once the contract audit is complete, the final step is to create a detailed report and perform an analysis of your findings. The report should outline any issues and failings revealed by the audit, identify opportunities to do things better and suggest adjustments to your contract processes.
For example, the audit might have highlighted inefficiencies in a particular workflow. Or you might have found that the wording of certain clauses is proving an obstacle to contract completion. The audit will show you the right areas to prioritise and help you set up monitoring mechanisms to look out for similar issues in the future.
A contract audit requires time, effort, and attention to detail. But it’s essential that you carry out regular audits to make sure all your agreements are clear and compliant. Keeping your documents organised will make your life easier when it’s time for an audit, helping you to select the relevant files and involve the right stakeholders.
Evaluate everything from payment terms to renewal processes, flag any clauses that need updating, and make sure the language is unambiguous. Remember to look at the associated financial documents and check that all parties are upholding their obligations.
As well as reducing the risk of financial losses, legal problems, or reputational damage, contract audits help you to improve the quality of your future agreements.
The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.