The 2024 Guide to Contract Compliance Audits
How contract compliance audits are a strategic solution for Chief Procurement Officers (CPOs) to reduce costs, mitigate risks, and identify untapped savings.
Table of Contents
Why Your Business Needs a Contract Compliance Audit
Procurement spends a lot of time and energy negotiating their contracts. But it’s challenging to maintain oversight once the contract is signed. The accounting department takes over billing, business owners are focused on the delivery of the goods or services, and your team is focused on the next contract. Even with the best intentions, most contracts get lost in the noise. Monitoring contract performance throughout the supplier management lifecycle can fall by the wayside quickly.
The average value erosion of a contract after signing is more than 8.6%, according to a recent IACCM report. For large organizations, that adds up to millions in lost profits quickly. So where is that money going?
A contract compliance audit can answer that question. Without auditing your contracts, value erosion and potential risks can easily go unnoticed as a result of multiple factors, including:
| Lack of governance or visibility | Overbillings are easily overlooked without a process in place to look for them. Procurement is often left out of the billing workflow, so they can’t see where the errors begin. And invoice approvers in more complex commercial models often lack the more detailed information they need from suppliers. Even when details are provided, they don’t have adequate time or resources to thoroughly check for mistakes. |
| Cost overruns | Projects that take longer and cost more than expected can quickly erode the value of the contract. |
| Vague or undefined terms | You and your supplier may interpret costs differently as a result of ambiguous language or a lack of transparency. |
| Lack of communication | 42% of procurement teams lack clear oversight responsibility for contract management. Without this structure, everyone assumes someone else is responsible, and mistakes go undetected. |
| Unexpected business events | External factors like market fluctuations and M&A activity cause unpredictable cost spikes, unreliable supply chains, and organizational disruptions. While many of these events are unforeseeable, a well-written contract and effective monitoring can reduce their potential impact. |
As you can see below, these minor discrepancies can snowball quickly. Especially if audits aren’t performed regularly.
Contract Value Erosion Over Time
While contract compliance audits are a critical part of the procurement function, they require time and expertise to perform them correctly. And procurement teams are already strapped for resources—CPOs listed operational workload as their #1 barrier to progress in 2023, according to a recent study by World Commerce & Contracting. Entrusting your contract compliance audit program with experienced, certified specialists is a best practice to capture cost savings and protect earnings without overextending your team’s bandwidth.
4 Benefits of Contract Compliance Audits
Benefit #1: Recover Up To 4% (Or More) Of Total Spend
A contract compliance audit can identify overspending and recover missed savings while meeting contract terms and conditions. SC&H’s contract compliance audit team typically recovers 2-4% of the transaction value audited. Savings and cash recoveries can quickly add up for large, multi-year contracts, returning millions back to the organization.
Common issues that contribute to missed savings and margin erosion include:
Billing and pricing errors:
- Over-billed rates, unit prices, or taxes
- Excess mark-ups and margins
- Overstated costs
- Unrealized media credits
Failure to comply with terms:
- Verbal and non-binding agreements
- Underpaid rebates and incentives
- Failure to pass through discounts
- Noncompliance with T&E policies
Lack of transparency:
- Related party transactions
- Noncompliant subcontracting
- End-of-fiscal period prepayments
- Understated sales or underpaid royalties
Non-compliance can show up differently depending on the unique challenges your industry faces. An auditor with experience in your industry will know exactly what rocks to look under to put money back in your pocket. SC&H has recovered millions for many different Fortune 500 clients, including:
Recommended Reading: How to Unlock Savings in Procurement Without Increasing Risk
Benefit #2: Improve Supplier Relationships
Communication, transparency, and trust are crucial to developing mutually beneficial third-party relationships. A contract compliance audit can restore confidence to ailing relationships, generating the earned trust needed to unlock value for both parties.
Contrary to popular belief, contract compliance audits can improve supplier relationships and increase trust by providing a structured mechanism for assessing compliance that facilitates communication and reduces conflict.
Optimized supplier relationships also separate the top-performing procurement teams from their peers. A SpendMatters study found that top performers who named supplier relationships a critical focus benefit from 35% more supplier collaboration and 58% higher multi-tier supply chain visibility compared to low-performers.
Procurement can utilize insights from an audit to identify mutually beneficial strategies and achieve common objectives. As shown below, cost savings can disappear quickly when supplier relationships aren’t properly managed and optimized.
Recommended Reading: 4 Procurement Strategies to Fight Inflation and Mitigate Contract Risks in 2023
Benefit #3: Increase Efficiency & Do More With Less
With 74% of CPOs noting operational efficiency as their top priority—and operational workload as their #1 barrier—contract compliance audits are an increasingly valuable tool for boosting productivity. Yes, audits can be complex and time-consuming, but the real operational value emerges from audit findings.
Contract compliance audits provide a wealth of data and insights into where contracts, processes, and controls are misaligned. Identifying each of these issues provides an opportunity to improve harmony within the organization. CPOs can leverage audit findings to update contracts, redesign processes, and enhance controls. By strategically aligning contracts, processes, and controls, CPOs will achieve the best possible business outcomes for their organizations.
Examples of How Audit Findings Can Be Leveraged
| Audit Finding | Action Taken |
|---|---|
| Contract renewals are delayed due to manual tracking and lack of centralized oversight. | The CPO implements a contract management system with automated renewal reminders and centralizes the renewal process to reduce the risk of disruptions. |
| Multiple departments engage similar suppliers independently, leading to redundant contracts and missed volume discounts. | The CPO consolidates contracts through strategic sourcing initiatives, negotiates bulk discounts, and centralizes supplier relationships, resulting in cost savings and operational efficiency. |
| Procurement processes heavily rely on manual and paper-based methods, causing delays and errors. | The CPO invests in a digital procurement platform, automates approval workflows, and introduces e-procurement tools, reducing processing times and minimizing errors for increased operational efficiency. |
Top-performing procurement teams are distinguished by their ability to streamline and standardize policies and processes to increase productivity. These high-performing teams deploy standardization strategies 20% more than low-performing teams, leveraging third-party solutions nearly twice as often as their peers to mitigate resource constraints. Engaging a third-party contract compliance auditor, rather than attempting the process in-house, is a best practice for these high-performing procurement teams.
Benefit #4: Mitigate Third-party Risks
Monitoring supplier risk can be extremely challenging. The inherent complexity and variety of risks that threaten your bottom line require both people and technology to monitor properly. Contract compliance audits provide a structured, streamlined process to assess and monitor the performance of third-party partners against contractual obligations.
- Your contract terms are complex: Contracts with multiple entities, large multi-year projects, data privacy concerns, or complicated pricing structures are examples of complex terms that can increase risk. An audit can ensure compliance with terms and effective operating procedures.
- The third-party has operational challenges: If your third party is not meeting operational objectives such as KPIs and SLAs, pricing compliance may also be lacking. An audit can help identify root causes of the operational challenges and contribute to improved operations.
- The third-party lacks mature controls: Small, private companies tend to lack the internal controls to maintain compliance, especially when experiencing rapid revenue growth. An audit can reduce risk and help the third party understand the value of investing in controls.
Business leaders noted data privacy as their top concern for third-party risk management. Security breaches are on the rise nationwide, with 41% of surveyed companies reporting an impactful third-party breach in the past 12 months (up 20% from 2021).
A single non-compliance incident costs over $14 million on average, and the average fine for GDPR violations starts at 2-4% of a company’s annual revenue. Periodic contract compliance audits can help you identify gaps in your contracts that expose third-party risk and optimize contract terms accordingly. Key strategies include:
- Requiring suppliers to maintain predefined data security measures
- Shifting liability of data protection to the supplier
- Ensuring responsibilities flow down to subcontractors
- Periodically auditing suppliers to confirm compliance with your requirements
Partnering with a team of third-party auditors can help ensure compliance throughout your supply chain and protect against data breaches without disrupting business operations.
Recommended Reading: How to Ensure Supplier Compliance with Data Protection and Data Privacy Laws 2023
How the Audit Process Works
A contract compliance audit may seem intimidating, but SC&H’s experienced, certified auditors have broken it down into four simple steps. We work as an extension of your team to complete audits with suppliers without disrupting operations.
Step 1: Planning
Identify audit candidates and contract risks, taking into consideration your overall objectives, and obtain buy-in from stakeholders
LEARN MOREStep 2: Examination
Acquire documentation from supplier, review for compliance, collect feedback on non-compliance from suppliers
LEARN MOREStep 3: Reporting
Deliver audit reports for each supplier audited, provide ongoing reporting and updates, and ensure stakeholders have the facts and context to make informed business decisions about audit findings.
LEARN MOREStep 4: Resolution Recommendations
Begin supplier negotiations to remediate non-compliance, obtain refunds from suppliers, and provide contract recommendations, process improvements, and benchmarking
LEARN MOREWhen is the Best Time to Conduct a Contract Compliance Audit?
- After significant organizational changes: Conducting audits after mergers, acquisitions, or restructuring ensures alignment with the new organizational structure and goals.
- Periodically throughout the contract lifetime: Implementing audits at scheduled intervals, such as biannually, can help identify any deviations or issues over time.
- Upon contract renewal or extension: The best time to correct misunderstandings or gaps is before the new contract is finalized. This presents an ideal opportunity to assess the existing terms, ensure compliance, and make any necessary adjustments for the new contract. The best time to correct misunderstandings or gaps is before the new contract is finalized.
- When a third party presents a key risk factor: Operational challenges, disclosures of past errors, whistleblower reports, data breaches, adverse news reports, and other such factors can indicate an urgent need for an audit.
- During supplier transitions: When transitioning between suppliers and terminating contracts, an audit can ensure a smooth handover and verify compliance with contractual obligations.
Choosing the Right Third-Party Auditor
Most organizations do not have the capacity, expertise, or technology to conduct regular contract compliance audits in-house. Hiring an independent specialist frees up your internal resources and reduces the impact on organizational workload.
When selecting an audit partner for your team, we recommend the following criteria:
- Specializes in contract compliance audits: This process requires highly specialized knowledge and experience. Engaging professionals who focus exclusively on contract compliance audits allows them to most effectively produce substantial ROI.
- Holds key certifications and qualifications: Verify that the auditor team is comprised of Certified Public Accountants (CPAs), Certified Internal Auditors (CIAs), and Certified Fraud Examiners (CFEs).
- Leverages both technology and people: Assess the firm’s use of technology for efficient data analysis and the intuition and experience of its skilled auditors to ensure they can handle the volume and complexity of your company’s contracts.
- Prioritizes effective communication and transparency: Choose an auditor that communicates transparent processes and methodologies, allowing your internal stakeholders and supplier stakeholders to understand the audit approach and timeline.
SC&H’s contract compliance audit team checks all these boxes and more. We offer more than three decades of industry experience implementing, designing, and executing effective third-party contract compliance audit programs for Fortune 1 to Fortune 500 companies in over 25 countries. Learn more about how contract compliance audits can help you meet your goals with a no-obligation assessment from the SC&H team.
Common Types of Contract Compliance Audits
Direct and Indirect Spend Audits
Recover overpayments through greater transparency and contract alignment. Our team works to identify inadvertent errors, reduce transactional risk, strengthen long-term supplier relationships, and monitor compliance.
Third-Party Risk Management
Understand risk indicators related to people, data security, data privacy, process design, and effectiveness, and policy compliance. We analyze financial, operational, cyber, privacy, and strategy risk to identify and mitigate potential exposures.
Construction Audits
Engage stakeholders throughout your capital expenditure project lifecycle to validate contract compliance, mitigate contractor risks, enhance processes, and strengthen internal controls associated with significant enterprise investments.
Shutdown and Turnaround Audits
Navigate large-scale manufacturing and refining shutdowns, turnarounds, and outages with smart contracts and monitored contractor compliance aligned with set terms and conditions to maximize quality, affordability, transparency, and ROI.
Accounts Payable Recovery Audits
Identify overpayments, detect risks, resolve unrealized credits, recover residual funds, and bolster financial performance with computer-assisted audit techniques, carefully conducted research, and a thorough examination of supplier records.
Royalty and Licensing Audits
Identify under-reported sales, omission of products from royalty calculations, non-compliant deductions, or formula errors that can lead to incorrect payments to enhance earnings, improve processes, and identify opportunities to strengthen contract language.
Forensic Data Analysis and Data Mining
Quickly and accurately expose potential fraud, waste, or abuse. We examine data sets against broad, specific, or combined criteria to identify irregular transactions and detect potential errors.
Contract Management
Proactively and consistently monitor contract compliance in real-time to ensure the effectiveness of operational and financial controls, optimize third-party relationships, and enhance the value of your contracts.
The Role of Technology in Contract Compliance Audits
Technology and automation enable audit processes to be performed at a larger scale than previously possible in the age of paper and calculators. Auditors leverage powerful data analytics tools to facilitate effective monitoring, identify patterns of non-compliance, and support the timely resolution of issues. Over the past three decades, SC&H has developed proprietary algorithms to identify anomalies that warrant further scrutiny efficiently.
Additionally, the SC&H team uses Power BI to create on-demand reporting portals that help visualize recurring problems within their clients’ contracts.
While technology can aid in the effectiveness of contract compliance audits, it does not replace an auditor’s intuition, judgment, and experience. Tools like AI and machine learning can still give way to errors and mistakes in contracts and third-party relationships. The best auditors leverage both people and technology to perform validation quickly and comprehensively.
This is why many organizations are turning to an external audit partner to help with compliance, risk mitigation, and risk corrections before mistakes can happen at scale.
Recommending Reading: How to Align Technology and People to Mitigate Contract Risk and Ensure Compliance
Common Myths of Contract Compliance Audits
No. Contrary to popular belief, contract compliance audits build stronger relationships. Restoring transparency and earned trust enables a more collaborative, mutually beneficial relationship. Insights garnered from the audit can be applied to future business between the parties to generate additional value and achieve desired outcomes.
When performed by an experienced auditor, the daily operations of the third party are minimally disruptive. The auditors create and communicate a clear timeline to ensure smooth execution and limit the involvement of key operational personnel, leveraging support from the third party’s back-office finance department instead.
No. An experienced auditor will generally require less than five hours of stakeholder support per audit—a time investment more than offset by the potential for cost savings and process improvement. This typically includes:
- A stakeholder conversation to review and sign off on audit specifications before work begins
- Updates provided during the audit process
- A discussion of results once the audit is complete
Additional support is required only on rare occasions.
Not necessarily. While a well-crafted audit clause guarantees access to third-party data and records, your ongoing relationship is usually sufficient to conduct an audit. Third parties typically cooperate with an audit request, as they recognize that it allows both parties to improve processes.
No. Most invoice and payment errors are caused by a misunderstanding of intricate contract terms, an unintentional oversight in manual billing processes, or programming glitches. Nonetheless, they are common and costly. An experienced auditor can pinpoint errors and their possible causes and then recommend internal control enhancements to reduce them in the future.
Since most billing errors are unintentional, legal or unilateral actions are rare. The most common resolution is a negotiated settlement, which is mutually agreed upon by both parties. This ultimately strengthens the third-party relationship with process improvements and contract clarifications that ensure future alignment and compliance.
Why Work With SC&H
Choose SC&H as your third-party contract compliance auditor for swift, transparent audits that can recover millions in overspending in as little as 30 days after audits are initiated. Our professionals bring more than 30 years of industry experience executing effective contract compliance audit programs for Fortune 1 to Fortune 500 companies in over 25 countries. We’re adept at navigating the intricate landscape of contract negotiations, ensuring resolutions faster than our competitors, and preventing future margin erosion. With an in-house team of Certified Public Accountants, Certified Internal Auditors, and Certified Fraud Examiners, we deliver immediate ROI and long-term cost savings through a contract compliance audit that pays for itself.
