If you run a business, you probably deal with various types of agreements and contracts on a regular basis. Whether hiring an employee, leasing a property, or selling a product, it is vital to have a clear and enforceable agreement that outlines the terms and conditions of the exchange. But what is the difference between an agreement and a contract? Why do you need a formal agreement for your business transactions? Moreover, why should you share your agreements and contracts with your certified public accountant (CPA)?
What is an agreement?
An agreement is a broader term that refers to a general understanding between two or more parties that they will, or will not, do something. For example, you may agree with your friend to go to the movies on Friday night, or you may agree with your supplier to deliver the goods by next week. An agreement does not necessarily create a legal obligation or a binding relationship between the parties. It is more like a statement of intent or a handshake deal.
What is a contract?
A contract, on the other hand, is a legally binding agreement that creates an obligation to do something. A contract must have four essential elements to be valid:
- An offer: One party proposes a specific exchange of value to another party.
- An acceptance: The other party agrees to the terms of the offer without any modifications.
- A consideration: Each party gives up something of value in exchange for something else of value.
- A legal capacity: Each party has the ability and authority to enter into the contract.
A contract can be written or oral; however, it is always advisable to have a written contract to avoid any disputes or misunderstandings later on. A written contract should include all the details of the exchange, such as the payment, the delivery, the quality, the warranty, and the remedies in case of breach.
Why do you need a formal agreement for your business transactions?
A formal agreement is a contract that follows a standard format and uses clear and precise language to define the rights and responsibilities of each party. A formal agreement can benefit your business in many ways, such as:
- Providing clarity and certainty: A formal agreement eliminates any ambiguity or confusion about what each party expects and promises to do. It also helps to avoid any miscommunication or misinterpretation that may arise from oral or informal agreements.
- Protecting your interests and assets: Safeguard your intellectual property, trade secrets, confidential information, and other valuable assets from unauthorized use or disclosure by the other party with a formal agreement. It can also help you to limit your liability and exposure to risks in case of unforeseen events or circumstances.
- Enhancing your credibility and reputation: A formal agreement shows that you are a professional and trustworthy business partner who respects the rules and honors their commitments. It also demonstrates that you value the relationship and the cooperation with the other party.
- Facilitating in dispute resolution and enforcement: A formal agreement can help you to prevent or resolve any conflicts or disagreements that may arise during the course of the business transaction. It can also provide you with legal recourse and evidence in case the other party fails to perform or breaches the contract.
Why should you share your agreements and contracts with your CPA?
Your CPA is a trusted advisor who can help you with various aspects of your business, such as accounting, taxation, auditing, and financial planning. Your CPA can also help you with your agreements and contracts by:
- Reviewing and analyzing your agreements and contracts to ensure that they are accurate, complete, and compliant with the relevant laws and regulations. Your CPA can also identify any potential issues or risks that may affect your business performance or tax obligations.
- Advising and recommending you on how to structure and negotiate your agreements and contracts to optimize your cash flow, profitability, and tax efficiency. Your CPA can also suggest any changes or improvements that may benefit your business goals and interests.
- Reporting and documenting your agreements and contracts to keep track of your income, expenses, assets, liabilities, and equity. Your CPA can also prepare and file any required tax returns, financial statements, and other reports based on your agreements and contracts.
Examples of when things go wrong without a formal agreement.
While having a formal agreement for your business transactions is highly recommended, some businesses may choose to rely on oral or informal agreements instead. However, this can lead to serious problems and disputes if things go wrong. Here are some examples of common situations that can go awry without a formal agreement:
- If you hire an employee without a formal employment contract, you may face difficulties in defining their role, responsibilities, compensation, benefits, and termination conditions. This can result in disputes over performance, expectations, wages, overtime, severance, and wrongful termination claims.
- If you lease or purchase a property or an asset without a formal agreement, you may encounter disputes over the ownership, possession, use, maintenance, and transfer of the property or asset. This can result in conflicts over rent, security deposits, repairs, damages, taxes, and liens.
- If you borrow or lend money without a formal agreement, you may face disputes over the amount, interest, repayment, collateral, and default of the loan. This can result in late payments, missed payments, collection actions, and lawsuits.
- If you start or join a business without a formal agreement, you may have disputes over the ownership, management, decision-making, profit-sharing, and dissolution of the business. This can result in conflicts over control, authority, responsibilities, contributions, and liabilities.
Agreements and contracts are essential for any business transaction. They help you to establish a clear and enforceable relationship with your business partners and help protect your interests and assets. You should always have a formal agreement for any business transaction and share it with your CPA for review, advice, and reporting. By doing so, you can ensure that your business runs smoothly and successfully.
Citations:
Rabkin, K. (2023, October 31). 10 examples of agreements (plus templates) to bulletproof your business. Blog. https://www.pandadoc.com/blog/examples-of-agreement/
Zaremba, Y. (2023, March 21). Why contracts are important and what is their purpose? Blog. https://www.pandadoc.com/blog/why-contracts-are-important/
Zaremba, Y. (2023, September 27). What’s the real difference between a contract vs. agreement? Blog. https://www.pandadoc.com/blog/contract-vs-agreement/