September 29, 2015 Getting Paid en_US Should finance charges (e.g. interest) be added to an invoice if the customer fails to pay on time? See 5 reasons for including finance charges. Should Your Invoices Include Finance Charges?
Getting Paid

Should Your Invoices Include Finance Charges?

By Ritika Puri September 29, 2015

As small business owners, we face many balancing acts and tightrope walks in our roles.

One of the most common challenges involves keeping customers happy, without putting too much strain on our core businesses.

It costs time, resources, and money when our customers don’t pay on time, for instance — the costs of processing fees can add up, too. Does it make sense to absorb these expense as costs of entrepreneurship? Is there a better way, that won’t risk upsetting your customers or hurting future sales?

Just like you, your customers operate on a budget. They may not have a choice or control into how quickly payments clear from a corporate account.

For this reason, before you consider charging any interest or finance fees, you need to establish a line of communication.

In the first month of working with your customer — or during a transition — make sure you take the time to explain your company’s payment processes and put it all in writing.

Explain how much you value your partnership, be clear about your needs, and ask about what has caused delays in the past, all with the goal of avoiding finance fees if possible.

These preventative measures will set expectations with your customer and create a foundation of constructive dialogue. Make it clear what steps to take to avoid getting billed with finance charges, altogether.

What Is a Finance Charge?

A finance charge is a fee that is charged as interest accrued on your customer’s account with your business.

On your invoices, you likely specify a payment term that outlines a specified window to receive payment. Net-10, Net-30 and Net-60 are common payment terms, which mean your customer must pay in 10, 30, or 60 days.

Finance charges on invoices often enter the picture when this payment window has elapsed, following a grace period that may be 7, 10, or 14 days. After this grace period, you will want to start charging interest — enough to cover your credit card processing and other financial transaction fees that result from nonpayment on the invoice.

In addition to having a clear discussion about these fees with your customers at the beginning of a new engagement, you’ll want to send several notifications to help your customers avoid over payment.

Alert your customer a week before your payment is due, and a day after the invoice due date has elapsed. At that point, you will want to send a finance charge letter as a heads up that you will charge interest every day — or week — that a payment continues to be late.

How Finance Charges are Good for Relationships

Charging interest on invoices is an important financial practice for many reasons.

Here are some ways that finance charges can result in stronger, smoother, and more transparent business relationships:

1. Creating Incentives to Follow Your Payment Schedule

Not all payment terms have to be based on negative reinforcement.

One of the many ways to encourage customers to pay early, is to offer an incentive, such as 2% off for paying their invoice early.

While it seems counterintuitive to offer discounts, even a small percentage off can improve the reliability of your cash flow and build stronger, long-lasting customer relationships.

2. Teaching Customers to Value Your Business

Nobody likes to see their bills balloon into bigger bills. An understanding of real, material consequences of paying late will encourage your customers to take care of what they owe, on time.

In many cases, customers simply forget to pay their bills or will de-prioritize an invoice due to lack of time or administrative priorities piling up. Especially for smaller bills, customers don’t want to deal with the nuisance of accounting for accrued interest. A finance charge will help keep payment operations on track and on-time.

By showing late charges and interest rates on your invoice, you make the expectations and consequences of late payments clear, which helps to avoid misunderstanding and conflict. that paying late has a real, stated cost to the customer. This is especially important if the customer has other outstanding bills (e.g. credit cards) that are charging a high rate of interest. If the small business does not charge interest as well, then there is no perceived benefit for the customer to pay their bill sooner than others.

3. Offsetting Time and Costs

Collecting late invoices costs every business money and time. Calls need to be made, and overdue invoices should be mailed by the staff. For example, if 20 hours a week is needed to collect accounts receivable, that 20 hours reduces the profitability of late-paying customers. This is a cost that many businesses, do not consider.

4. Creating Concessions

When the customer doesn’t pay an invoice in full, interest can be used as a concession in exchange for their payment. For example, many customers may ask if the interest can be dropped if they pay in full right now.

As a small business owner, you might also decide to drop these fees to increase your negotiating power. In any case, it will force you to talk with your customers, as you approach a potential solution.

Check with your CPA and your particular state’s usury laws where the customer is located, because there may be restrictions on the maximum interest rate you can charge.

5. Creating Incentives to Follow Your Payment Schedule

Finally, not all payment terms have to be based on negative reinforcement.

One of the many ways to encourage customers to pay early, is to offer an incentive, such as 2% off for paying their invoice early.

While it seems counterintuitive to offer discounts, even a small percentage off can improve the reliability of your cash flow and build stronger, long-lasting customer relationships.

Crafting Your Billing Agreement

It’s important to create a billing agreement that is clear in stating the terms of the interest to be charged. It needs to indicate when interest charges begin and how often they will be applied to the balance. 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.

Even if your business creates a standard policy for charging interest, each debt and customer needs evaluation and consideration. Factors like the length of the business relationship or payment history will influence your decision. Get the opinion of team members that have worked with your client in the past.

Make sure that your accounting software can automatically bill interest on invoices so it does not become a source of added accounting work. Quickbooks can be set up to assess finance charges to all or selected customers through its set up procedures.

While it’s easy to focus on non-paying customers, it’s important to remember that most companies want to pay their bills on time. Be firm, but also remember to be understanding and polite. Being concise, clear and consistent with your collection attempts can help you maintain a positive cash flow while minimizing costs.

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Want to learn more about how to get paid on time? Read this Complete Guide to Invoicing.

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Ritika Puri is a marketing consultant, business sociologist, and entrepreneur who runs Storyhackers. She enjoys helping companies reach and engage with audiences who love to learn. Read more