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

You’ve found yourself in the situation that no business owner wants to deal with: an invoice is way past its due date.

It’s been months since you sent the invoice, and there’s nothing but crickets in your inbox and your small business bank account. Now you’re wondering if you should start charging your customer a late payment fee, in addition to chasing after the outstanding balance.

Figuring out how to approach past-due invoices is yet another challenge that business owners need to deal with. And, while there isn’t a default solution that applies to everyone, late payment fees are worth considering to instill a greater sense of urgency in your customers.

What is a late payment fee?

A late payment fee is an extra charge a client needs to pay when they don’t settle a bill by its agreed-upon due date.

To charge a late payment fee, you need to include those payment expectations within your original contract or sales agreement—it’s not something you can tack on last-minute when you’re angry that an invoice is unpaid.

Additionally, when charging a late fee penalty, the original invoice must list both the payment due date and the late fee percentage or amount.

What is a reasonable late payment fee?

You can charge a flat rate or a monthly finance charge, which is usually a percentage of the overdue amount. 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 that, you’ll divide it by 12 to get your monthly rate. Then you multiply the monthly rate by the total amount due to get the monthly late fee charge.

Let’s clear this up with an example: You charge a 12% annual interest rate. A $12,000 project is overdue for payment by one month. So, you multiply the outstanding $12,000 by your monthly interest rate (which is 1% or .01). You arrive at a monthly finance charge of $120, which means your new outstanding balance is $12,120.

Is it legal to charge late payment fees?

Yes, charging late payment fees is completely legal. However, as previously mentioned, you can only do this if your original contract allows for it.

There are also state-specific regulations and laws regarding the amount a business owner can charge for a late payment fee, so make sure you’re in the loop on what your state allows and prohibits.

How to deal with late payments and unpaid invoices

Late payments are frustrating enough on their own. But, even worse, they can have a ripple effect within your business. When you don’t have the money you were counting on, you might not be able to pay your own suppliers or bills. That’s especially true if you’re running on tight profit margins.

  • Take a deep breath, as you aren’t totally powerless here. You have a couple of different options to encourage your clients to pay promptly.

Charge a late fee

Like we mentioned previously, adding a late fee to overdue invoices can inspire your clients to get moving on issuing payments. Just remember to check the rules in your state.

Use a payment plan

In some cases, a customer might hit a financial rough patch that leaves them unable to pay the invoice by its due date. In those cases, you can offer customers a payment plan.

These plans should clearly outline the minimum amount of payment required along with any interest rate charged for the outstanding balance. This gives your customers the option to pay minimum payments each month, without their bill going to collections.

Offer an extension for first-time late payments

If you have a customer who regularly pays on time but suddenly finds themselves without enough money to pay one month, you can consider offering a one-time extension. You don’t want this to become a habit, but doing it just once shows your clients that you value the relationship and are willing to compromise.

You could also implement extended payment terms in 60-, 90-, or 120-day time frames so customers have more time to pay in full.

Invoice management tips

Late fees can help you get the money you’re owed. But, you might be able to avoid assessing a late fee altogether if you have the right invoice management practices in place.

Use automated invoicing

Rather than waiting on snail mail, consider automated invoices to limit the number of late payments you receive. This makes it easy to quickly send out invoices, which saves you time and effort and gets your invoices into your customers’ hands as fast as possible.

If you have clients you bill regularly, you can also set up recurring billing to automate those recurring payments.

Keep track of unpaid invoices

You’re going to have a hard time collecting past due payments if you don’t know that they’re past due in the first place. To avoid losing out on money you’re owed, keep track of your invoices and follow up on the late ones.

That’ll help you maintain a healthy cash flow and avoid tearing your hair out when you realize that an invoice is way past due—and you didn’t catch it until now.

Send payment reminders

Payment reminders are a less aggressive way to collect the money you’re owed instead of going straight to a collection agency.

Send a reminder email to your customer that includes the invoice, the past-due payment date, an explanation of any late fees that have been incurred, and a link for them to make immediate payment.

Don’t be afraid to be firm—you want your client to take this reminder seriously and make payment a priority.

Expand your payment options

Inflexible payment options could be a reason a customer hasn’t paid your invoice on time. Consider expanding your payment methods so customers have plenty of ways to settle up.

If possible, let your customers pay with cash, credit cards, electronic funds transfer, checks, third-party payment systems, and wire transfers. With that many options, there’s really no excuse not to send payment your way.

Offer discounts for prompt payment

Sometimes it’s better to lead with a carrot than a stick. Consider offering a small discount, 1% or 2% of the bill, in exchange for payment within 10 days or a time period you prefer. Providing a discount for speedy payment can incentivize your clients to get moving.

How to create a late payment policy

A late payment policy is one more step that will help protect your business from delinquent accounts. Here’s how to approach your own.

1. Understand your payment terms

Before you can document an official policy, you first need to understand what you will and won’t accept. This includes determining:

  • Payment terms: Are you doing Net 30 payments? Do you expect payment immediately? What are your standard payment terms?
  • Payment methods: What forms of payments will you expect? Checks, cards, or cash? All of the above? Can you take online payments?
  • Incentives: Will you provide an incentive for early payments? If so, what is it?
  • Late fees: Will you assess a fee for late payments? When does that fee kick in? How much is it?
  • Next steps: Will you ever send an overdue invoice to collections? If so, at what point does that happen?

Grab a notepad and jot out your answers to these questions. They’ll lay the foundation for your more formal policy.

2. Cover your policy with your clients upfront

Now that you have that sorted out, it’s time to document a simple late payment policy that you and your clients can easily refer back to.

The easiest place to do this is in the “compensation” section of your client contracts. That’s a legally-binding document, which means you’ll have some recourse if your customers don’t abide by the payment terms that they agreed to.

Since you likely have your clients sign a contract before you ever start any work, including your payment policy there means they need to acknowledge that they’ve reviewed those terms. There’s no arguing that they didn’t know about your policy. But even so, it can be helpful to point it out to them at the start and ask them if they have any questions.

3. Include your payment policy on your invoice

Your invoice should always include your payment terms (for example, Net 30 payments) and a clear payment due date.

However, you can reinforce your late payment policy even further by including it briefly and directly on your invoice. This doesn’t need to be anything lengthy or complicated. Even a short line like this at the bottom of your invoice can go a long way:

Overdue invoices will be assessed a late fee of 1% for every month that payment is overdue. Your prompt payment is appreciated.

The more obvious you make your payment terms and policy, the less room your clients have to plead ignorance.

Don’t let late payments hold your business back

Everybody wants to be paid on time, yet overdue invoices are a problem many business owners need to face head-on.

Late payment fees can show your customers that you mean business when it comes to collecting the money you’re owed. And, even further, it can instill a sense of urgency and get you paid faster.

After all, you’ve earned that money, and you deserve to collect it without headaches and hassles.


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