Making Contract Compliance Audits Preventiveby
If you already have a contract compliance program in place for your clients, you know they help recoup historical cash leakage. But in an age when automation and continuous improvement are reshaping ideas about value, is that enough?
Supplier contract audits can work well, but on their own, the best they can deliver is a proportion of what’s already been lost. What if you could help raise the proportion saved by stopping value leakage before it starts?
Making Audits Deliver More
A typical contract compliance audit looks back at supplier payments over the previous three to four years. Completing an audit can take up to six months, with regular input from procurement and finance needed throughout the process.
Suppliers and buyers are accustomed to this, but many on both sides have started asking why technology and best practice aren’t helping flag issues sooner. It’s a good question, with an even better answer: By moving to proactive methodologies, your clients can now stop cash from going out the door, and turn contract compliance audits from reactive to preventive.
Decades of experience combined with advances in technology are transforming the traditional audit into an opportunity to uncover underlying issues in billing compliance that let repeated overpayments slip through. When those are identified, sustainable long-term controls can be implemented that stop loss before it happens.
Assessing Contract Risk and the Root Causes of Leakage
There are a number of key methodologies for rooting out and addressing the underlying issues that cause value leakage. To overcome auditing challenges and make them more proactive, there are three ‘triggers’ most auditors look for to stop leakage before it happens:
This involves clarification of actual terms to eliminate grey areas. The risk lies in ambiguities that lead to differing interpretations of contract language. If these can be identified early, it’s easier to avoid future disagreements.
Loose contract language will always be interpreted by suppliers to benefit themselves. When ambiguities and potential for future leakage are identified early in the contracting relationship, these root causes to value leakage can be proactively mitigated.
Labor-intensive work will often include cost-based labor rates. Proactively evaluating the cost build-ups included in these labor rates will help to mitigate overpayments once billing begins. In addition, sometimes contracts fail to provide proper build-up methodologies or a clear right to audit these costs at a later time.
Evaluating contract language proactively is a huge step to avoid potential overcharging. The contract language should provide visibility over the accuracy and transparency of all billing rates. Auditing the base wage and the cost components attached to each proposed rate will identify the real cost of wages and benefits, and enable the buyer to exclude non-allowable costs.
In some cases, invoices can be audited proactively for compliance to the contract before approval and payment. Several best practices come into play to ensure accuracy in price and labor rates charged, mark-up percentages being applied, inclusion of allowable versus non-allowable costs and whether or not the supplier is providing proper documentation for allowable costs.
Change order documentation can provide ample opportunities to identify hidden contract risks. Change orders are based on estimates, and there needs to be reconciliation between the estimate and what was actually paid.
If the cost applied in a change order turns out to be less than the estimate, a credit will be owed. Adding controls relating to approval documentation can eliminate the risk.
Proactive Audits are Already Delivering Value
The developer of a multi-year construction contract recently implemented a preventive contract compliance program for the build of a 3-million square foot facility. A joint venture contract was in development for two construction firms, covering a scope of work that included 920 acres of land, 8.3 million cubic yards of earth that needed moving, and a budget of $1.5 billion.
Monthly invoicing included costs for the two general contractors, plus 35 subcontractors. There were 600 orders made from the site each day on average. Monthly pay allocation included hundreds of pages of documentation.
Given the scope of the project and the scale of the budget, conducting a traditional, recoveries-focused audit at the end of the project would have been incredibly difficult and time-consuming. Pre-award analysis revealed several issues related to auditing rights and cost definitions. In particular, significant non-allowable costs attached to many of the rates were being charged.
On labor rates alone $7 million in preventative savings were secured for the contract owner. Additionally, more than $4 million in savings due to payment error prevention were secured.
The Power of Prevention
Proactive methods designed to mitigate leakage risk in your client’s environment can be extremely beneficial in preventing errors before they occur. Traditional contact compliance audits haven’t lost their essential value.
In fact, the process of identifying historical recoveries enables auditors to conduct the risk assessments needed to determine where systemic issues are hiding. Gathering that intelligence is vital to optimizing contracts and stopping money from going out the door.
The added scrutiny suppliers find themselves under can also lead to self-correcting behavior. If they know a proactive contract compliance audit process is in place, they’ll be more likely to treat invoices with the rigor they deserve. Any lazy assumptions built into a supplier’s invoicing processes (for example, ‘well, they paid it so it must be approved’) will also wither away if they know that anomalies will be challenged.
Jon Daniells is VP Audit Operations at PRGX, a global recovery audit service. Having started in recovery audit in 2001 and working across multiple industry verticals, he brings 35 years of industry experience and offers extensive supplier contract audit expertise.