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Running a business

Should you charge late payment fees? Pros and cons to consider

Here’s a situation no business owner or freelancer wants to deal with: invoices that are way past their due date. You’ve provided the agreed-upon service or product. You’ve sent out an invoice. You’ve waited and waited, and now it’s been months since you sent out the original invoice. Do you charge your customer a late payment fee in addition to pursuing the outstanding balance?

One of the toughest decisions businesses have to make is how to approach overdue invoices. Freelancers and small business owners are particularly vulnerable to the negative effects of overdue payments. Why? Because when you’re running a business, multiple late invoices can negatively impact your cash flow and ability to run your operations.

In this article we’ll explore when you might need to assess late charges, how to create a late payment policy and how to encourage prompt payments. Keep reading for a full explanation of late payment fees or jump ahead to the section that directly answers your query.

What is a late payment fee?

A late payment fee is an extra charge imposed on a client for not paying a bill by its agreed-upon due date. To charge a late payment fee, you must include payment expectations within your original contract or sales agreement. In addition, when charging a client a late fee penalty, the invoice provided must list the due date and the late fee percentage or amount.

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What is a reasonable late payment fee?

Business owners have the option to charge a flat rate or a monthly finance charge, usually a percentage of the overdue amount. Companies typically assess a 1% to 1.5% late fee.

illustration shows woman at computer, with the text “businesses can only assess a late fee if the original sales contract outlines this option. Companies typically assess a 1% to 1.5% late fee.

To calculate the interest rate for a late fee, you’ll first need to decide on the annual interest rate. Once you have your annual interest rate, divide that by 12. This number will be your monthly rate. Then you’ll multiply the monthly rate by the amount due to get the monthly late fee charge.

Let’s look at an example:

Let’s say you charge a 12% annual interest rate. A $12,000 project is overdue for payment by one month. To figure out the monthly finance charge, you’d multiply the outstanding $12,000 by the monthly interest rate (1% or .01). You’d arrive at a monthly finance charge of $120. The new outstanding balance would be equal to $12,120.

Is it legal to charge late payment fees?

It is legal to charge late payment fees; however, as mentioned, you can only do so if the original contract allows it. In general, you should charge no more than around 10% annually and break it down to a monthly charge.

How to deal with late payments and unpaid invoices

When you don’t get paid on time, it can have a ripple effect on your business. Without money flowing in from services rendered, you might not be able to pay your suppliers or utility bills. This is especially true if you’re running on tight profit margins. You have a few different options to encourage clients to pay promptly: charge a late fee, use a payment plan or offer an extension.

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Charge a late fee

One way to handle unpaid invoices is to charge a late fee. Remember: pay attention to usury laws or seek out legal advice if you’re unsure of the maximum interest you can charge.

illustration shows stopwatch, with the text “Late fees can vary, and you have the option to charge a flat rate or a percentage of the customer’s bill.

Use a payment plan

In some cases, a customer might hit a financial rough patch and be unable to pay their invoice by its due date. For example, many Australian workers have recently become unemployed as a result of the COVID-19 pandemic. Instead of charging a late fee, you can offer customers a payment plan.

Payment plans should clearly outline the minimum amount of payment required along with any interest rate charged for the outstanding balance. A customer can continue to make the minimum payments each month to avoid having a bill in collections.

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Offer an extension for first-time late payments

If a customer regularly pays on time but doesn’t have enough money to pay one month, consider offering an extension to the next month. You can also implement extended payment terms in 60-, 90-, or 120-day time frames so customers have more time to pay in full.

illustration shows a man sitting at a computer, with the text “Freelancers spend an average of 20 days a year tracking down money owed for late payments. Source: The Association of Independent Professionals and the Self-Employed

Invoice management tips

Maintaining well-managed invoices is the first step to ensuring you get paid on time.

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Use automated invoicing

Rather than waiting on snail mail, you may want to consider automated invoices to limit the number of late payments you receive. Automated invoicing allows you to quickly send out invoices, which can save you precious time and effort. If you have clients you bill regularly, you can also set up recurring billing to automate recurring payments.

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Keep track of unpaid invoices

It’s a good idea to get into the habit of keeping tabs on unpaid invoices . After all, you’re going to have a hard time collecting overdue payments if you don’t know they’re overdue in the first place. To avoid losing out on money you’re owed, track your invoices and follow up on late ones.

Regularly tracking invoices can help you create a healthy cash flow and ultimately help boost your net profits. An easy way to track and manage your invoices is by using accounting software like QuickBooks. With QuickBooks, you can set up invoice reports and notifications to alert you to both paid and unpaid invoices. You can also choose a set time each month or quarter to check in on overdue invoices.

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Send payment reminders

Payment reminders can be an effective strategy to resolve overdue payments. Payment reminders are a less aggressive way to request the money you’re owed instead of going straight to a collection agency.

Deciding between sending an email or mailed reminder? Well, email reminders are quick and easy to send compared to mailed reminders, which require postage and delivery time.

Make sure your invoice reminder includes accurate contact information for your company’s billing department. It’s important to make it as easy as possible for your customer to contact you. In the event of issues with an invoice, like making a payment deadline or reporting a billing error, easy-to-find contact information streamlines the resolution process.

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Expand your payment options

Inflexible payment options can be one reason a customer doesn’t pay an invoice on time. Consider expanding your payment methods so customers have plenty of ways to settle up. Do you accept credit card payments from all credit card issuers, including American Express and Discover? If possible, let your customers pay with cash, credit cards, electronic funds transfers, cheques, third-party payment systems and wire transfers.

Offer flexible ways customers can send you their payment information, too. Some customers might feel more comfortable dropping off a physical cheque at your shop or giving their credit card information over the phone. If you use QuickBooks to send your invoices, you can offer various online options that make it easy for your customers to make payments.

illustration shows abstract invoice, with the text “Incentives for paying on time: Late fees might make your bill a priority, but you can also give a prompt payment discount to achieve the same result.

Offer discounts for prompt payment

Sometimes it’s better to lead with a carrot than a stick. Consider offering a small discount, for example 1% or 2% of the bill, in exchange for payment within 10 days or a time period you prefer. Discounts in exchange for early payment also may help lower the number of late invoices.

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How to create a late payment policy

Want to make sure your business is protected from overdue accounts? Here’s our step-by-step guide for creating a late payment policy for your business.

1. Send out an invoice with late payment policy

Make sure the invoice lays out the details of late charges up front. It should also lay out the payment terms and the number of days the customer has to make the payment.

Include details like the invoice creation date, payment terms, total amount due with tax, product or service rendered, contact information, business name and payment due date. Accounting software from QuickBooks can automate these details for you.

2. Send out payment reminders

You can send an email invoice directly after the transaction occurs and a follow-up email if the bill goes unpaid after a certain period. A payment reminder should nudge the customer politely to call attention to the upcoming invoice obligation.

3. Charge a late fee for an overdue payment

If a customer still has unpaid invoices, send another reminder with the late charge that details the total outstanding balance. Give a deadline for payment with a warning that you will be forced to consider your legal options in claims court if the overdue payment isn’t settled.

A debt going to a collection agency has serious consequences. It can lower a customer’s credit score and be a serious blemish on their credit history. As a result, the prospect of facing these consequences can prompt a customer to take the invoice seriously. Hopefully, though, your overdue invoices won’t get to this escalation point.

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Wrapping up: late payment fees and their impact on business

Everybody wants to be paid on time. But with COVID-19-related financial issues or just forgetfulness, late invoices might be a problem you have to face head-on. If you’re struggling to collect payments on time, consider changing your terms of payment or altering the late payment language on your invoices. It’s also a good idea to use automated invoicing systems and accounting software like QuickBooks. Business owners can use QuickBooks to manage all invoices and track down missing payments more easily.

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