Contracts are finalised every second of every day. For businesses in particular, contracts act as a vital tool for building new relationships, extending existing ones and closing transactions.
However, formalising relationships is just one of many purposes performed by contracts. The widespread use of contracts means that there are now countless ways in which a contract can help a business (if managed correctly).
According to the IACCM, there are multiple purposes behind contracts, and these can often become confusing as a result.
Fear not, though. This page explores why contracts are important in business, what they are used for, and our advice on how to optimise your contract process to ensure you are receiving the most value from your contracts.
What is a contract?
A contract is a legally binding agreement between two or more parties. Once signed, this contractual agreement creates a promise that certain rights and obligations will be fulfilled by each party. In essence, a promise is at the heart of every contract.
Whilst the definition of a contract is simple, those promises can be complicated in practice. At Juro, we try to simplify and explain these processes wherever we can:
- What makes a promise a contract? (Elements of a contract)
- When is a promise not a promise? (Agreement vs contract - what’s the difference?)
- How can we understand the whole universe of promises we’ve made? (How to create a contract repository)
- What if we need to change the promise we’re making? (How to amend a contract)
- How do we know when it’s time to make good on all those promises? (How to manage contract renewal)
However, before becoming waylaid by the headaches caused by contract processes, it is important to understand precisely what the purpose of a contract is, and why they have become an essential tool for all businesses.
What is the purpose of a contract?
The main purpose of a contract is to formalize new relationships and outline the various legal obligations each party owes to the other.
Today, most contracts are agreed between businesses, not people. Whilst individuals will sign basic contracts occasionally - to sell a house, or accept a job offer - businesses sign legal agreements in the masses, with partners, customers, and suppliers. The truth is, contractual agreements form the backbone of every commercial relationship.
Why are contracts important?
As recognised in a report by the IACCM, contracts perform various important business functions, making them critical business documents for many organisations. The importance of signing a contract stems largely from the fact that it performs the following purposes:
1. Contracts serve as a record of rights, responsibilities, and obligations
Foremost, contracts function as a reliable record of the rights, responsibilities, and obligations of the parties who have signed it.
An effective contract will describe, in detail, what duties each party has to one another, how these ought to be performed, what they will be measured against, and when. As a result, contracts act as a useful document for each party to refer to when reminding themselves of the responsibilities they owe and are owed.
By using contracts in this way, businesses can apportion and minimise risk, since there is a degree of predictability and clarity surrounding who is responsible for doing what, and on what terms. This fundamental knowledge can then be relied on by a business to inform subsequent business decisions.
2. Contracts make private promises legally enforceable
The intention to be legally bound is a core component of any contract, and it requires that for a contract to exist and be enforceable by law, both parties must share this intention.
This means that, unlike other, less formal promises, a promise in a contract is one that you have a legal right to enforce in court, typically where another party has breached the terms originally agreed and caused you loss of some sort.
For all businesses - big and small - a contract will protect you in the event of wrongdoing. Not only will a contract empower you to take legal action if the terms you agreed to are violated, but it will also explain which jurisdiction you can take this action under, and what steps to take to do so.
3. Contracts formalise a relationship between parties
Before the contract process even begins, two or more parties will have agreed to work together in a mutually beneficial way.
Contracts are a way of formalising a relationship between businesses, as well as outlining how you’ll maintain this relationship, what obligations you need to fulfil, how long you will fulfil them for, and for what price.
Fast-growth companies that are scaling will need to enter these relationships frequently and nurture them well, so understanding what is expected of each other and being accountable for the promises made is essential to developing a more fruitful relationship in the coming years.
4. Contracts ensure you get paid
Another purpose of a written contract is to stipulate the payment process and capture revenue. When a SaaS company offers to deliver their service to another business, for example, there is almost always a cost attached. A contract will explain this cost, along with other details, like:
- The exact amount of money due to be paid
- How frequently payments will be made
- The payment method to be used
- The costs associated with late payment
- Terms and dates relating to auto-renewal
Therefore, a contract also acts as a safeguard to guarantee your business’ right to payment on a certain date.
5. Contracts provide an opportunity to increase revenue
Many businesses can also use contracts as an opportunity to generate higher revenue. This is commonly achieved in two ways:
A. By negotiating contract terms to increase value
It’s simple. By negotiating contract terms that work in their favour, like increasing the price paid for a certain software subscription, or upselling a certain service, a business can increase their revenue. Contract negotiation is the perfect opportunity to make the deals being agreed upon more valuable.
B. By making the contract process more efficient
Contracts are designed to make a deal official, which results in revenue. Therefore, any barriers that prevent fast and frequent agreement are also barriers to revenue.
For example, if your legal team is blocking a contract due to constraints on their time, your business team could miss opportunities to close deals. This is a problem easily resolved by software that enables business teams to self-serve, yet many businesses continue to lose potential revenue by following age-old, inefficient contract workflow processes.
Making the contract process as seamless, simple, and efficient as possible will eliminate these missed opportunities and costly wasted time. To ensure that contracts serve you better as a route to revenue, discover a more efficient way to use them - hit the button below to find out more about all-in-one contract automation with Juro.