In an uncertain market, businesses may wish to conduct an audit of all contracts to identify areas for potential savings. This may also identify contracts which are no longer commercially viable. In addition, if there is concern the contracting party is in financial difficulties, the audit will detect circumstances where it may be necessary to amend the business’ terms to protect against any adverse effects.
Any such audit should include supply and purchase contracts with key customers and suppliers but also contracts which facilitate the administrative functions of the business, from HP agreements for equipment, IT support and maintenance and utility suppliers. Whilst not all contracts are evidenced by written terms, the starting point for any contract audit will be the written contracts signed by the business. Take heed that the contracting parties practice can arguably vary the terms of a written agreement.
How can the audit assist with identifying savings?
Firstly, there may be provisions within the contract which have not been utilised to date, such as minimum purchase obligations and exclusivity clauses or lack thereof. For instance, if there is no requirement that the business exclusively acquire the specified supplies or services from the contracting party, there is an opportunity for the business to source from multiple suppliers. The business should be cognizant of any minimum order amounts within a contract and not to fall foul of such clauses when considering alternative suppliers.
Secondly, there may be scope for negotiation on specific terms such as pricing or the scope of work. The position of each party will clearly impact on progression on any such discussions. However there may be changes within the market that were not factors when pricing was agreed at the outset, such as increased competition and more competitive alternative suppliers.
Thirdly, the review may identify contracts that are no longer commercially viable and termination may be the obvious option. When considering termination, due care must be given to the requirements so as not to give rise to a claim for damages on the grounds of wrongful termination. Is a particular form and period of notice required? Is the contracting party in breach of the terms and provision is made for termination without notice? Discussions in respect of termination may even open the dialogue to renegotiate better terms for a new contract.A contract audit will also assist should a business be concerned about the solvency of their contracting parties. Is it perhaps time to review how the party is invoiced and the terms on which the pay? It may be necessary to renegotiate shorter payment terms and put good debt control procedures in place to ensure those terms are enforced. Is a review and revision of the credit limit of existing customers required to provide more comfort on realising payments? In terms or prospective clients, it would be prudent to undertake credit checks and where appropriate request personal guarantees from directors or a parent company. Clearly, such investigations should be proportionate to the value of the contract in each case.
Care must be taken during negotiations to not jeopardise positive relationships, however, a view may be taken if any future business is unlikely and this should be addressed on a case by case basis. Proactive businesses conducting regular contract audits will ensure their contract terms are sustainable and it will also help off-set any solvency issues of their contracting partners.
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