Contract Risk Management Guide: How to Develop an Effective Risk Scoring Plan

Risks are present in every business deal. If not managed effectively, they can significantly damage your company, meaning it’s essential to have an optimized contract risk management process. Using contract management software helps you streamline your risk contract management plan, increasing your chance of achieving your goals by automating the entire process.

What is contract risk management?

Contracts are the backbone of any business. They are the documents that explain how your company will reduce risk and grow. In most circumstances, they are sophisticated documents filled with legalese and potential risk. However, the factors that determine their purpose are straightforward; one side wants the largest return and the other a little expenditure, and both want the deal to be as risk-free as possible.

Contract risk management aims to define the maximum value of an agreement via compliance tracking by detecting, controlling, and minimizing possible risks throughout its lifetime. 

The importance of contract risk assessment

Business contracts define and manage the rights and obligations of any new partnership or agreement. As a company expands, the complexity of its procedures and the number of agreements that must be managed also increase.

However, agreements differ between organizations and industries. Therefore they cannot be addressed in the same way. Managing risk throughout a business deal’s lifespan is critical to the contract management process. The approach may help safeguard your organization and maximize earnings by detecting and mitigating risks.

Most common types of contract risk factors

Every deal has risk, meaning it’s critical to understand the many forms of risk while managing them. When you understand the various types of contractual risks, it’s easier to identify them and take the proper precautions against them.

The four main types of risks are:

Financial risk

Some examples of financial risks include credit, liquidity, asset-backed, and equity risks. These risks can arise from a variety of sources, including late payments, cancellations, or missed delivery dates.

Legal risk

If a corporation violates the terms of an agreement, the counterparty may take legal action against them. Legal risks are classified into three types: dispute, compliance, and regulatory risks. Many situations, such as inappropriate or overused confidentially disclosures or missed responsibilities, might result in legal consequences.

Brand risk

Brand risk is linked to the public and consumer perception of your company as a direct result of financial, legal, and security risks. A brand must strive to reduce brand risk since it may have a significant negative influence on its reputation, leading to monetary losses.

Security risk

Contracts frequently contain large amounts of confidential and sensitive information about the parties involved, making security threats one of the most detrimental complications your company might face. If not prevented, security threats can damage your company’s reputation, lead to financial losses, and create legal disputes.

What is contract risk scoring?

Risk scoring, or contract risk analysis, is a way to identify hazards in an agreement by assigning a representative risk score to each relevant issue and generating an overall risk score. Your scoring plan assists in standardizing your management process and ensuring that your company does not take on more risk than intended. This stage will also provide your negotiators with more effective guidelines, allowing them to negotiate conditions in each deal that favor your company.

With risk scoring, you can make informed decisions about:

• Which contracts your company needs to terminate
• Which contract terms and conditions need to be altered
• How to lower your company’s overall risk score

How to develop and standardize a contract risk scoring plan

1. Establish what risks your company wants to evaluate

Each deal carries some degree of risk for your company. If a client does not pay or if you fail to meet your customer’s expectations within the time limit specified, you may face serious repercussions. The purpose of your contract risk analysis is to reduce those risks. When developing your risk management strategy, begin by determining the risks your company wants to examine.

These may include:

• Company finances
• Legal accountability
• Potential warranty issues
• Termination concerns
• Loss of business integrity
• Automatic rollover clauses
• Intellectual property issues

Some of these risks are more harmful to your company than others. Risks that arise in an agreement, particularly those sought by a customer, may not be worth accepting in some cases. In other situations, you may be able to mitigate the risk differently. Before beginning your scoring system, carefully identify the risks you want to score.

2. Assign a “point value” to each risk

A “point value” should be assigned to each risk. Risks are often rated on a 1-5 scale, with 1 representing little to no risk and 5 representing a significant risk to the organization. When you add them up, you’ll obtain an average risk score. A high-risk contract should be reconsidered or avoided entirely, but a low-risk contract might help guide you in the right direction.

After you’ve assigned a value to your risks, spend some time scoring some of your existing agreements to get a better picture of your average risk. For your scores to be effective, you must first understand what your risk is and how much risk the firm is ready to handle.

3. Automate the contract scoring process with contract management software

The key to automating the risk scoring process is contract management software. The contract management system offers the ability to score a deal as soon as it enters your system. Your company can also customize when you want your contract management system to generate and emphasize risk scores.

How a CLM tool can help with contract risk assessment

You may generate risk ratings based on factors and thresholds that you set in the system. The program then gathers all of the different data points using a comprehensive and systematic approach to data management. You can look at risk indicators like an arrangement above a particular amount that does not include a specified Limitation of Liability provision, an agreement renewing during a specific month, or when an outdated form of a governing law provision was included.

The ability to easily gather this information and assign a risk score to each agreement based on your thresholds and standards makes reporting one of the most important facets of your risk management plan. Dashboards generated by contract management software provide vital report data in a graphical, user-friendly style that you may use to assess the overall risk of your agreements.

The benefits of effective contract risk scoring and analysis

Effective risk management will decrease financial and operational risk while increasing earnings for the company. On the other hand, poor risk management exposes the organization to increased expenses, lost income, and the prospect of legal action from the counterparty.

Contract management software has the ability to alter how teams engage with their agreements. By automating low-value operations like agreement review and maintenance, your team can spend less time on tiresome contractual procedures and more time on higher-value tasks.