Have you had the chance to assess and review what's in your contracts? Are your suppliers, vendors, and partners following what they have agreed to before?
Take a moment to reflect on the above questions and see what answers linger in your mind. If the answer is no, or you are skeptical about how to go about it, keep reading.
The real task of contract management begins only after someone signs over the dotted line. Yes, you and your clients are obliged to uphold the commitments made in the contracts that were signed. In essence, the contract audit exactly accomplishes this. It guarantees that all terms and conditions are properly adhered and spots any possible issues before they become expensive.
In this blog, we bring to you a contract management audit checklist - a step-by-step guide to conducting effective contract audits. It acts as a guiding compass and helps you perform a successful cost audit, compliance audit, or term audit.
10 steps for performing a contract audit
You will learn how to conduct a successful contract audit in the following steps. So let's begin.
#1 Determine whether the audit is proactive or reactive
You can conduct reactive contract audits in the wake of particular business events like mergers and acquisitions, the latest round of fundraising, or significant capital expenditures. Proactive audits are routine, yearly, or more frequent health checks of your agreements.
💡Pro tip: The first thing you should do is verify if the contract audit at hand fits into any of the categories mentioned above because the purposes of each of these categories vary.
#2 Find the scope of the contract audit
See if you are auditing your entire contract or specific sections of the agreement. Are you examining certain contract types or complete portfolios? This information helps you set the scope of the contract audit.
💡Pro tip: For scaling businesses, it makes the most sense to start small with batches (review by contract type) and apply the lessons learned to other clusters of contracts. So, at the end of this exercise, you will have a rough count of the number of contracts and the category of contracts you'll audit.
#3 Establish the appropriate timing
There is an element of anxiety involved in auditing by any standard. So, finding the right time to conduct one is in your best interest. It is imperative to remember that more comprehensive contract audits require extensive and special attention. Getting one performed during tax season or other similar occasions should be your last resort.
Ideally, before deciding on the time to start the audit, study your current business priorities and ongoing projects. This process will aid you in estimating approximate duration for contract review.
💡Pro tip: Consider any hard deadlines within your industry or business when choosing the time for a contract audit.
#4 Clearly state your goal
Audits can be time-consuming. So, knowing what you would like to accomplish at the end of auditing thousands of contracts is essential. Moreover, companies have a variety of reasons to push for contract audits - control costs, improve the quality of contracts, and drive process efficiency.
Below are some examples of audit objectives –
- Getting a grip on your obligations
A clear goal of contract audit is to become fully aware of the requirements outlined in your contracts and any potential risks. At the end, you should be able to learn your liabilities and rights.
- Analyzing the dynamics of billing
A thorough audit could confirm invoice amounts - check if you are being charged appropriately and ensure you aren't overcharging or underdelivering to your customers.
- Mastering what's inside your contracts
The terms of your contracts typically dictate how you should handle non-compliance. You should be aware of your choices. Does the contract require arbitration? What rules govern a lawsuit's venue, choice of law, filing requirements, and damages clauses? Your contract audit can merely be a drill of answering the questions mentioned above.
- Discovering process improvements
There is always room to do better when it comes to managing contracts. Further, you can find data-driven suggestions for improving internal procedures and controls with contract audits.
- Setting internal checks and balances.
Finalize measures and procedures to spot and address non-compliance. Contract audits help you devise methods to ensure how contracts are implemented or carried out.
💡Pro tip: Communicate the audit objectives to all stakeholders and align everyone around those goals. Create smaller milestones for all parties involved.
#5 Create a dedicated audit team
Businesses could hire an outside consultant to handle the audits or form a team of internal employees. Sometimes companies combine internal and external stakeholders to gain more benefits.
Your legal team could easily take on the audit job if you only have a small number of contracts. However, a neutral third party can be helpful if your firm needs to assess its entire portfolio, has never undertaken an audit previously, or is working with decentralized storage.
Additionally, roles and responsibilities must be specified to avoid work being missed or repeated. The team is crucial to the security of the audit. Therefore, team members must be granted the proper rights, permissions, and privileges.
💡Pro tip: Historically, an audit team comprising a proper mix of internal and external members has worked well for most organizations.
#6 Foster collaboration
When you start including all the necessary stakeholders in contract audits, they begin to work. After all, all teams employ contracts. Include everyone who has used templates to create contracts, not only the legal department. This process increases openness and builds confidence.
Also, external stakeholders, or those with whom you have sealed agreements, should be considered. It is crucial to collaborate well with contracting partners and involve them in the audit process.
To avoid the opposing side becoming defensive or even hostile, this should be done in a friendly manner. The objective of an audit should not be to assign blame or guilt for errors or problems but rather to use the data to make improvements as we advance.
💡Pro tip: Inform everyone of the contract's goal and their respective duties.
#7 Communicate audit details to everyone
The secret to a successful contract audit is communication. Inform each team member and other contractual parties in writing of the audit's purpose, objectives, and scope. By doing this, you achieve two things–
- The growing tension that’s inherent in contract audit is removed. This open message guarantees that no one is under personal investigation.
- Tear away the information barrier you could have had before. You get access to everything you need.
💡Pro tip: Avoid top-of-the-mind oral communication (steer away from speaking spontaneously) and create a solid argument to explain why you request an audit.
#8 Prepare for security and privacy concerns
Check to see if your contracting partner can give you access to all the documents you require. If not, it acts as a blocker. Look for audit clauses within your agreements in this particular instance and cling to your contractual rights as outlined in the contract. The above-discussed open dialogue with other parties can be helpful in this situation and provides solutions.
💡Pro tip: It's always best to hire a professional service provider to conduct contract audits, as they would be familiar with every party's security and privacy requirements.
#9 Organize essential documents
Gaining access to relevant contracts is likely to be the first issue you run into when starting a contract audit. Finding and organizing these contracts manually before a quick and effective audit can be complex, whether saved on a platform like Box or Google Drive, printed out, or filed in storage cabinets.
💡Pro tip: An intelligent contract repository and contract management software simplify organizing your files before the contract audit.
#10 Debrief, learn lessons, and implement
A contract audit's primary objective is to identify potential issues and address them before they worsen. Therefore, a contract audit is a valuable opportunity for businesses to identify their strengths and weaknesses.
Even the auditing process itself can be used as a learning tool. Those involved in the process should summarize the audit process and any contracting challenges that need to be addressed and use this information to plan for the future.
💡Pro tip: Create a final report with non-compliance instances and specific remediations. Also, it's a good practice to highlight how you plan to improve the internal process for positive results.
Employing CLM for contract audits
Thanks to CLMs - Businesses have real insight into all contracts with customers, sales partners, suppliers, and other stakeholders across the company. Some benefits of conducting audits with CLM include:
- Keeping track of compliance: Team members can work with the proper stakeholder for fulfillment and monitor the compliance status with the help of workflows.
- Using obligation tracker: Contract managers can utilize obligation management to track critical terms and dates. This functionality helps them fulfill obligations on time and maintain compliance.
- Helping cross-functional teams succeed: Effective contract obligation management is also vital for other departments like sales, which manage massive contracts, to ensure that a company fulfills its customer responsibilities.
“The key to managing contract compliance is establishing a robust process. For instance, as part of proactive audits, teams should identify relevant departments and stakeholders who track and certify adherence or non-adherence.”
Diwyata Burbure | Senior VP, Legal Tech
Learn more about how SpotDraft can help you meet promises and compliance by requesting a demo today. Make contract audits a breeze, and start improving the contracting processes with us.
P.S. Hope you’re all set with this ‘how to audit contracts’ checklist. In our next post, we will discuss the types of contract audits, the significance and benefits of performing an audit, pain points ingrained in the manual contract audit process, and how SpotDraft helps you simplify the contract audit process from start to finish.