Why don’t more companies perform forensic contract compliance audits?
Particularly when times are hard, there are significant recoveries and savings to be had if high proportion of an organisation’s costs are in supplier contracts. As an example, an organisation might have 70% of its costs tied up in contracts (not untypical in Oil & Gas upstream) and, as research shows, there is a likelihood of 9% value leakage (wastage): Based on those figures, a potential of 6.3% of the organisation’s costs that could be saved from contracts without affecting performance. There is, therefore, much to be gained by monitoring contract performance. Of course, different organisations will have different contractual structures but whatever your the situation, an approximation of the potential for contract cost savings is fairly easy to estimate. Given that these benefits can be realised without a loss of service, loss of staff or other internal resources, this would seem to be an obvious thing to do. Not so much low hanging fruit, as practically scraping the ground. However . . . . . .
As our experience shows, many organisations do not audit or review their contracts or supplier invoices at all. This is usually because they believe that there is no risk of value leakage. After all, they have a contracts department, a finance department and operational staff making sure things are ok, don’t they? And yet, when we perform forensic contract audits, we always find recoveries and gaps in contracts an internal control. so it would seem that things are not ok and money continues to seep away. Here are some of the root causes:
- Operational Staff may not have the time or commercial knowledge to check invoices thoroughly. We find that approximately 50% of all invoices do not attach the supporting documentation necessary for them to be checked. These invoices, sometimes to the value of hundreds of thousands of USD, have been approved after only a superficial look at the front sheet.
- Finance staff do not have time, knowledge, or technical understanding of the contract to be able to perform proper checks.
- Contract Administrators may be focussed on new contracts, rather than the post-award management of existing ones.
- Amendments and other changes are often made informally (often by email) and without any control; making it impossible to check invoices thoroughly due to departure from the documented Terms & Conditions.
- Contracts are often not adequate to cover the commercial risks and not subject to quality checks – the result being ambiguous T&Cs based on poor strategy, many gaps, and often with unacceptable supplier-led amendments slipped into the rates schedules.
- A lack of robust internal control processes which mitigate against a lack of commercial discipline within client companies.
All of these things we find on nearly all contract audits we perform; and they are not limited to one company, or to one industry. This is why there is so much to be recovered in the present and saved in the future from the forensic investigation of current contracts.
The effect of contract audits is to determine what is actually happening with current contracts. Given the degree of imperfection described above, this will nearly always produce recoveries which exceed the cost of the audit. But the real benefit is the light this throws on improvements to be made in the contract itself and the internal control processes within the client organisation. This will be between five and ten times the size of cash recoveries in our experience.
So I paraphrase the question:
Why are Contract Audits not used as a key component of most costs-cutting strategies ?
It seems a no-brainer! Help me understand this phenomena, please; just add a comment below:
CorGuv Limited 
I have worked for 3 major oil companies over 25 years and the each one had differing views on contract compliance and audits. Each one thought that the controls within the company would identify errors on invoices. How wrong they were as this philospy leads to each department thinking other departments were doing the review, in fact no one was.
LikeLike
In a lot of cases, the finance department (which everyone thinks is looking after that “sort of thing”) is looking at the “Big Picture” ie the management accounts of the company and their high flyers are in that section. The seniors in the finance group consider “Account Payable” to be for the clerks and graduate accountants learning their trade while the “grown ups” report the management accounts to the companies directors.
In a lot of cases neither the contracts department or finance want to dig deep nor do the other departments want the work to sort poor contractural procedures that have always been slipshod when they are identified.
Yes, it will take a large culture change in a lot of organisations to get these basic checks done and save large amounts of expenditure. I would think that a good few companies go out of business for that very reason
LikeLiked by 1 person
Spot on Eddie. It is quite difficult to open the culture to accept that things are less than perfect. We have, in some cases, discovered problems with internal processes which no-one would admit to, even though we had proved it and it had resulted in millions being lost. The overall result is that no learning or improvement takes place. I guess this explains why our experience is that , on average, contract management has got steadily worse over the years. This is aggravated by the loss of expertise from the contracting departments.
LikeLike
Very interesting article.
I would like to add one small point from my own work experience in dealing with Procurement Compliance and Contract Audits, where some auditors and audit processes/checklists seem to be more focused on making sure all the paperwork is available and that no gaps are in the process and DO NOT seem to focus on what could have been done more efficiently or how the business could benefit from a more enhanced/streamlined alternative.
Procurement/Contracts Compliance and Audits should keep the end-result of the business in mind and strive to be fit-for-risk, more buy-in will be a result of this in my opinion.
LikeLike
Thanks for your contribution Imad. I aree with you – we are very much focussed on improvements in effectiveness. Around half of our findings are about improving things in future. We generally find these are worth many times more than the cash recoveries in any of our audits. Sadly, not all clients follow-up on our recommendations and incorporate lessons learnt into future contracts.
LikeLike