An Expert Guide to Vendor Audit Process for Compliance

Vendor relationships have changed from simple transactions to important connections that affect financial stability, cybersecurity, regulatory compliance, and brand reputation. As businesses scale internationally, use outsourced operations, and build technology-based systems, managing vendor risk has become a key concern.

A single unreliable vendor (whether it is because of fraud or inappropriate internal controls, financial instability, or failure to adhere to applicable regulations or standards) can place an entire operation at risk. Therefore, vendor audits have developed from an optional process to the essential third line of defense for keeping supply chains secure, improving financial processes, and enhancing overall enterprise security.

What is a Vendor audit?

A vendor audit is a clear process that involves checking how vendors operate, what agreements they have, and how they relate to the organization. This ensures they follow company policies, legal rules, and industry standards.

The main purpose of a vendor audit is to improve how vendors perform, find and fix issues and risks early, and maintain good relationships with vendors.

If a company does not address vendor risks, it may face compliance issues, which can lead to fines, lawsuits, financial losses, and damage to its reputation.

What are the Key Elements in a Vendor Audit?

During a vendor audit, the following points must be considered as the main components of a vendor audit framework:

Risk management

Evaluating the potential risk that may be associated with the vendor. It may include vendor fraud, financial instability during disruptions, or security gaps that may directly have consequences on your business. Organizations must assess vendor history, including their financial records, to identify any red flags in order to mitigate risks before they become severe.

Regulatory and Compliance Assessment

Vendors should meet certain regulatory standards to ensure they are fully compliant. Auditors verify whether the third party they have onboarded upholds the compliance requirements with the risk management strategies of your business structure.

Operational Vendor Evaluation

Vendors should meet the performance standards required of them. During a vendor audit, the performance of a vendor is evaluated on some key metrics. This includes:

• Ability to meet deadlines
• Delivering the quality of the work
• Their processes and workflow
• Infrastructure and quality controls

Security and Data Protection Controls

According to a third-party risk report, 60% of data breaches involve third-party vendors. With security being the utmost concern in today’s business world, a vendor audit program should also include assessing the vendor’s security protocols to mitigate the risk of cyber attacks or unauthorized access to customers’ data and other confidential information.

What is the Vendor Audit Process?

A vendor audit procedure consists of sequential steps that enable an organization to evaluate and confirm that its third-party vendors operate in accordance with the organization’s policies and procedures. Here’s what the vendor audit process looks like:

• Setting up Objectives Before an Audit

Planning in advance is important for an audit. Firstly, identify the objectives of the audit. This may include compliance, quality, security, response, delivery, and risk management. Ensuring all aspects of a vendor audit helps businesses get the desired audit results.

• Making Vendor Priority List

Focus on making a list of the important vendors based on how needed their services are and the risks involved. During this step, an auditor must ensure that the audits are done according to this list, informing the suppliers of the transparency of the process.

• Collection of Data

Gather records such as supplier records, contacts, old audit reports, financial statements, and compliance reports to review and verify the vendor. The purpose of this is to check if the vendor you are planning to onboard is reliable and safe to partner with.

• Conducting the Vendor Audit

The nature of audits can be both onsite and offsite. This may depend on the scope of the process. A vendor compliance team may run a physical check at the supplier’s location to observe their workflow and evaluate their staff. In contrast, an off-site vendor audit is done remotely, where a vendor’s records are reviewed, and interviews are conducted.

• Evaluating Vendor Audit Result

Evaluate the vendor’s performance against clear expectations. Determine where they can improve, which includes service level and compliance with the contract. Demonstrate how they can improve, which could include training and better communication of expectations. Make plans for addressing compliance issues. List the deadlines for resolving each issue, outline specific timeframes for resolution, assign accountabilities, and establish performance metrics for tracking progress.

• Reporting and Action

After the vendor assessment, develop a comprehensive vendor audit report to provide to the supplier. Give recommendations to assist the vendor in complying with their business activities and provide questions for follow-up and support.

• Ongoing Monitoring

Continuous monitoring should be an integral part of the audit process. Once the audit is completed, it’s important to continually monitor the vendor’s performance. This will ensure businesses continue to achieve the desired levels of performance and build better rapport with suppliers in the long run.

Why Are Vendor Audits Important?

Doing vendor audits is crucial to having a risk management strategy. Here’s why businesses should evaluate their vendors:

• Enables companies to develop a better understanding of vendor performance and operational execution and to identify potential risks or issues before they disrupt business continuity. 
• Identifies risks earlier, such as compliance gaps, market disruptions, or operational weak points, so they can take measures to help avoid problems before they escalate.
• Improves vendor performance by creating opportunities for actionable feedback in an effort to enhance performance and thus long-term mutually beneficial relationships.
• Increases operational efficiency by identifying follow-on process gaps early and establishing a continuous feedback loop to drive higher productivity and workflows.
• Strengthens brand reputation by ensuring the vendor is following acceptable quality standards, sustainable sourcing practices, or industry-standard practices consistently.
• Enables better cost control by uncovering invoice errors, contract breaches, or quality issues, which will ultimately reduce costs from wasted resources and eliminate legal liability.

Best Practices for Effective Vendor Risk Management

• Be sure your vendor audit checklist reflects the current regulatory requirements. 
• Regularly update the audit process to reflect new laws and industry-wide standards.
• Regularly conduct vendor audits on a consistent basis, such as every quarter.
• Train internal teams on the latest compliance policies and audit processes. 
• Set audit objectives to support overall business goals.

The KYB’s Approach to Vendor Audit

Businesses that work with third parties (vendors and suppliers) must follow the Know Your Business rules. This means they need vendor audit services to investigate and evaluate suppliers, ensuring compliance and mitigating potential risks by checking for penalties, sanctions, adverse media, or regulatory enforcement. The KYB’s comprehensive due diligence process is streamlined, ensuring every vendor you onboard is aligned with regulatory and ethical practices. With an updated database of 1300+ official sources from more than 250 countries, our platform helps organizations manage vendor risks and build trustworthy relationships through informed decisions.