PURCHASING - 29.03.2011

Reviewing new agreements

That second pair of eyes

Scenario. As the finance person you are probably asked to review new agreements with suppliers on a regular basis. Your perceived role is one of looking over the terms, just to see if there is anything onerous in them that has been missed by others. These contracts could range from minor overheads, e.g. for a postal franking machine, to a significant spend on a direct cost, e.g. using a new supplier for one of your product’s components. But what should you be looking for?

What should you be looking for?

Three key areas. Terms included or attached to an agreement are mostly pretty standard fare. Generically, the additional finance costs of any agreement are found in three areas: (1) specified set-up fees; (2) any ongoing variation charges/penalties; and (3) cancellation fees/penalties when you want to cut short the arrangement. Budget holders who negotiate or renew agreements typically fail to pay attention to these areas, focusing instead on just the cost or level of service they are getting from the deal.

Tip 1. Establish an understanding with the budget holder about what you will or will not be looking at in this type of limited review. You are not a legal expert. It’s the three key finance costs of any agreement you will be focusing on. Of course, if anything odd leaps off the page, you would certainly bring it to their attention.

Tip 2. Issue a short report highlighting and commenting on the key financial terms in the agreement (see The next step for an example report).

Agreements are made to be broken

Look for notice periods. One thing that you should seek out in any agreement is the clause that refers to “Notices”. If you want to cancel/vary an agreement, your company will have to give adequate notice of its intention to do so to the other party. In practice, how much notice and what particular form it takes varies. For example,

“A notice may be delivered in person or by first class post or fax and shall be deemed to have been served if by hand when delivered, if by post 48 hours after posting and if by fax six hours after dispatch.”

The risk. Failure to give adequate notice can lead to additional costs for your company in the form of either cancellation charges or being locked into an onerous contract for longer than it needs to be. Indeed, more and more no obligation deals are being offered with short-term incentives; however, most of these require giving notice to cancel during that offer period.

Tip. Keep a simple register of company agreements, which not only sets out the renewal date but also highlights the notice giving date and the form this notice has to take (see The next step). This will also help you plan for those interruptions from the budget holders triggered by renewals of existing agreements.

For a sample report highlighting the key financial terms in a contract (FC 03.07.02A) and an example agreements register (FC 03.07.02B), visit http://financialcontroller.indicator.co.uk.