Want Bottom Line Savings? Think About an Audit Rights Review
Businesses today rely on contracts with suppliers and partners to maintain the flow of materials and services necessary to create and deliver their products or services to market. Executives and attorneys may spend hours, days, or even weeks negotiating the terms of a contract, but the employees who execute on the agreement during the normal course of business often use standardized processes that may or may not comply with the provisions to which the parties agreed. These unintended deviations can lead to costly errors and omissions for your business. If your company counts on contractual relationships with other businesses to run smoothly, are you certain that you aren’t leaving money on the table as the result of non-compliant operations?
Agreements can include an “audit rights” clause that provides the parties with the opportunity to perform a close examination and comparison of contract details with actual processes. When a party to the contract chooses to exercise its rights under such an audit rights clause, the resulting review could deliver savings and ultimately improve efficiencies for both parties. Depending on the type of contract and the activities involved, an audit rights review can make a significant contribution to your company’s bottom line.
Assess Where the Greatest Savings Will Be
If you engage an outside consultant to help with an audit rights review, you want to do some work up front to determine if your potential savings will justify the fees you will pay. The first step is to take an inventory of your existing agreements and look for those most likely to provide cost recovery opportunities. These opportunities may be found in agreements such as:
- Vendor Master Service Agreements (MSAs)
- Joint Operating Agreements (JOAs)
- Purchaser and Participation Agreements (PPAs)
- Final Settlement Agreements (FSAs)
Within the above agreements, it’s important to recognize the benefits inherent in the audit rights clause, including:
- Timing of transactions and refund request allowances
- Audit rights explicit in the agreement
- Other rights implicit in general business operations
- Execution of the right to audit
Once you know which contracts have potential cost recovery opportunities, you need to understand the accounting allowances set forth in those agreements. Allowances can provide insight into areas where the execution of the contract varies from the actual terms. Some allowances may show that an unintended deviation is more efficient than the process described in the agreement, while others will indicate where a variation has created a financial drag on the relationship between the parties. When it comes to cost recovery, relevant allowances include:
- Direct charges
- Indirect allowances
- Timing of billing by vendor/partner
- Other clauses applicable to accounting for operations
Be Transparent: Create a Clear Statement of Work
If you haven’t been exercising the audit rights clause with your contractual partners in the past, it’s good to give them a “heads-up” that you will be starting the process soon and will continue to perform these reviews in the future. These reviews can be a “win-win” for both parties, as they often identify efficiencies that are already in place and simply need to be reflected by a favorable adjustment to the agreement. At Hein, we recommend that you implement these reviews as a standard practice with all vendors and partners. It’s important to share your policy with your contractors so that no one feels they are being singled out as a result of suspicion or mistrust.
Create a clear “statement of work” with the consulting firm that you choose. Set expectations up front and specify that you want a collaborative effort between the firm’s consultants and your employees assigned to the project. Hein & Associates offers a team approach to collaboratively work with your in-house employees if you choose. While the initial review is primarily an outsourced project, we involve your team and equip them to identify future concerns internally. Firms that take your information, review it, and come back to you with a standard list of recommendations don’t provide the kind of insight and support that may benefit your people and enable them to keep agreements on track in the future.
Collaboration with your consultants should include subject matter experts within your company working with the firm to identify and review the specific contracts and processes that may be causing issues and concerns for the company. The team should:
- Identify any cost overruns, expected or unexpected.
- Provide operational insight by involving the various business units and soliciting input.
- Provide direction to the external consulting firm on areas of focus in order to better guide the effort.
You should receive clear and concise documentation from your consultants in order to effectively qualify recoveries. Be sure to validate the consultant’s findings and confirm that appropriate documentation has been provided to support those findings. At Hein & Associates we make every effort to ensure documentation is comprehensive and covers all of the bases to effectively achieve results.
Choosing Who to Partner With for Your Review
There are some types of consultants to avoid hiring for audit rights reviews.
- Consultants who use a cookie-cutter approach that tries to force your business practices into their models and processes: Hein looks at each client individually and builds an audit plan specific to the unique requirements of the business.
- Consultants that work purely for a percentage of savings found: Remember, this review is an opportunity to improve processes and manage the relationship between your company and its vendors or other business partners. Consultants working for a percentage of recoveries are much more likely to come up with random issues to see what sticks for recovery purposes. Their fee structure may discourage them from identifying the non-financial issues of concern and suggesting improvements that could ultimately improve your company’s value added processes. In addition to that concern, the main purpose of the review is to identify legitimate costs and recover them for your business. Paying a percentage of costs recovered to a consultant can have a significant impact on the relationships with your vendors and/or partners and influence the overall recovery amount returned to your business.
To get full value from this process, you should choose a consultant that considers your relationships with your vendors and/or partners. The firm that helps to audit your contracts needs to be open and transparent with its communications to your business associates. You need to be able to understand those communications and control the touch points to make sure your relationships are not being harmed. When executed properly, a review of audit rights under a contract can provide recovery of previous costs, streamline processes that reduce future costs, and result in a stronger relationship with your vendors and partners.
July 16, 2015