It’s a perennial question: Should you add finance charges (e.g. interest) to invoices if your client fails to pay within the agreed terms? Many freelancers and self-employed people hesitate to implement this policy out of fear that doing so may upset their client. The truth is that if you have clients that do not consistently pay on time, they are not the type of client you should work with anyway.
Charging interest on invoices can be a good financial practice for many reasons. Let’s look at four of them here.
1. It Shows the Penalty for Paying Late
The interest rate is displayed right on the invoice. It shows that paying late has a real, stated cost to your client. This is especially important if your client has other outstanding bills (e.g. credit cards) that are charging a high rate of interest. If you do not charge interest as well, then there is no perceived benefit to paying you sooner than others.
2. It Will Have a Psychological Effect on Your Client
With interest charges, your clients see their bill getting larger every month, and no one likes to see that. This is especially effective on small bills where interest becomes a real nuisance on the actual money owed. Remember, your clients also need to account for interest paid on their end, which many do not want to do.
3. It Will Save Time
Make no mistake; collecting late bills costs all freelancers and self-employed people money and time. Calls need to be made and overdue bills need to be re-sent. For example, if you spend 5 or 10 hours per month to collect accounts receivable, that ‘wasted’ time reduces the profitability of your work. This is a cost that many self-employed people do not consider.
4. It Can Be Used as a Concession at a Later Time
When your client pays in full, interest can be used as a concession in exchange for their payment. For example, some of your larger clients may ask if the interest can be dropped if they pay in full right now. If you comply, it can smooth out the relationship with your client.
Best Practices for Imposing Finance Charges
It is critical to create a billing agreement that clearly states the terms of the interest to be charged. It needs to indicate when interest charges begin and how often they will be applied. Use a phrase on the invoice in bold letters that states, “Accounts not paid within 30 days of the date of the invoice are subject to a 2% monthly finance charge.”
Using a clear statement now means less confusion later if and when interest appears on your client’s statement. All invoices should include the balance payment due, interest rate and the interest accrued. Interest should be charged on interest due.
While you should have a standard interest charging policy, each client should be considered on an individual basis. Factors like the length of the business relationship or payment history will influence your decision.
Finally, make sure that your accounting software can automatically bill interest so it does not become added work for you. QuickBooks Desktop can be set up to assess finance charges to all or selected clients through its set up procedures.
While it’s easy to focus on non-paying customers, it’s important to remember that most of your clients want to pay their bills on time. That being said, being polite and diligent in the collections process sometimes yields more effective results than a threat of an interest charge.
That last point goes for non-paying clients, too. You can be polite, but you can also be firm at the same time. Being concise, clear and consistent with your collection attempts can help you maintain a positive cash flow while minimizing costs.