Contracts and Procurement- Important Terms and Contract Types

Learning how to implement a contract procurement process properly can minimize a company's inventory and operation expenses by ensuring smooth production flow.

Contract procurement consists of all of the procedures necessary for a business to purchase goods and services from a vendor. Starting at identifying a company's need for a product, the procurement cycle is not complete until the purchase order contract is finalized with the supplier.

This process includes facilitating requests, purchase orders, invoices, contacting vendors, and placing the final order. If a contract procurement procedure is inadequate, businesses can lose capital from inefficient operations and improper stock replenishment.

Establishing a procurement cycle can streamline ordering, receiving, and auditing stock, saving businesses time and resources. Procurement contracts also help develop partnerships with suppliers, ensuring the quality of products and services.

The benefits that come with efficient procurement cycles depend on a business's knowledge of procurement contracts and setting the appropriate terms and conditions.

5 Key Contract and Procurement Terms

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All purchases made by a business, whether big or small, should be outlined by a detailed contract for record purposes. Contracts are especially vital when a company and vendor decide to start a partnership because they describe terms for both parties. When drawing up an agreement, companies should include elements such as-

1. Goods and Services
The main reason for companies and vendors signing contracts is the trade of capital and goods. Therefore, explicit terms must be provided that details what product or service the supplier is offering, along with specific quantities. This avoids any confusion that may occur regarding what was expected of the vendor.

2. Cost and Payment
When the products and units are selected, both organizations must reach an agreement on the price and time of payment. It is also important to outline the payment method and repercussions if the company fails to pay on time.

3. Confidentiality and Ownership
When trading goods, there can be some confusion about where the ownership lands. While some partnerships agree that once the supplier starts production, the assets are technically owned by the distributor, others prefer trading ownership at the transaction. There is also the matter of confidentiality when it comes to externally sharing intellectual property. In this case, the company must state that the vendor must not share any information regarding production to any other party.

4. Liability Terms
It is not unusual for vendors to limit their liability for any expenses, risks, or damages that may occur in production. However, businesses should set disclaimers that negate these clauses in cases of misconduct, fraud, or negligence as a safety measure. This will protect the company against legal actions if the supplier decides not to withhold their end of the deal.

5. Breaches
In case of dire circumstances, both parties must decide the repercussions if either were to breach the contract. Long-term arrangements often include the privilege for either party to terminate the agreement without warning or reason. However, these conditions can be altered according to any specificities either organization may have.

The 3 Main Contract Types

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Contracts provide a necessary framework for projects and partnerships taken on by companies and suppliers. There are specific agreements for bartering goods and services that outline what is expected to be fulfilled.

Depending on the circumstance, a business can use one of three contract types, including-

Fixed Price

Also known as a lump sum contract, a fixed price agreement is ideal when the business has a set order in mind. This means the company wants a specific product and number of units and does not intend to alter the order. By placing a fixed price, the business can limit purchase costs and have an accurate prediction of production and delivery.

Once the supplier has signed the agreement, they are required to fulfill the order within the set timeframe. This element takes away any confusion and prevents the risk of legal repercussions, as the seller is liable for fulfilling the order specifications.

Cost Reimbursement

Sometimes referred to as cost disbursable, the cost reimbursement contract is used when an order is uncertain or could change. This contract keeps the supplier on schedule, under the company's budget by paying once the request is completed.

Often, the vendor is guaranteed a fee of the business's profits, but the parameters are negotiable. For example, the value of the fee could be based on how quickly the supplier fulfills the order, exceeds expectations, or stays under the business's budget.

However, since cost reimbursement contracts are settled upon uncertain terms and conditions, there are higher risks. Some vendors try to increase their cost by arguing for scope creep, or the increasing requirements needed to complete an order.

For example, a supplier could experience scope creep if they initially assessed an order and found it would take two weeks to fulfill with limited resources but later realized they underestimated the time and materials required. The extra time and raw materials needed to complete the good or service would cost more money, so the vendor may try to upcharge the business. To prevent this, companies can set a cap that creates a limit for the maximum cost regardless of scope creep.

Time and Materials

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Most common in labor and service providers, time and materials contracts evenly split risks between the company and supplier. The business is responsible for supplementing the materials needed as well as the hourly rate for all included laborers. It is vital that the buyer sets a flat rate limit and clearly defines the qualifications of workers to ensure quality work without going over budget.

Implementing an efficient procurement system and using appropriate procurement contracts can directly affect a company's profits through capital management. Understanding which type of contract best fits the business's goals can help them stay under the budget while meeting their quality standards.

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