Billed in arrears: What it is, how it works, when to use it

Running a business comes with its share of difficult decisions, like choosing the right billing method. Between upfront payments, installment plans for customers, and billing in arrears, the latter is the trickiest. But understanding how it works can make a big difference in keeping your operations running smoothly.

The flexibility of billing in arrears can be a lifesaver, especially when it comes to maintaining strong client relationships and ensuring your services align with client satisfaction. But how does it work, and when should you use it? Let's dive in to find out how this billing method could benefit your business.

• How billed in arrears works
• Billing in arrears vs. billing in advance
• Pros and cons of billed in arrears
• Putting billing in arrears in place
• How to use billing in arrears effectively
• Choose the best payment setup for your business
• Billed in arrears FAQ

How billed in arrears works

Billing in arrears means charging customers for products or services after you’ve delivered them. Here’s how it works:

1. You deliver the services or products: With arrears billing, you provide the service or product upfront without requiring immediate payment. This is common in industries like utilities, subscriptions, and consulting.
2. You issue an invoice after completing the work: Once the service period ends or the project is complete, you issue an invoice in arrears. The invoice reflects the cost of the services already rendered or products delivered.

Customers pay for work: The customers then pay for services they’ve already used based on the invoices you’ve provided—an arrangement often referred to as paid in arrears.

Billing in arrears vs. billing in advance

When it comes to handling payments, there are two primary methods: billing in arrears and billing in advance. Each approach offers unique advantages depending on the nature of your business and client relationships. 

Billing in arrears means charging customers after services or products have been provided. This is common in industries where the cost depends on usage or the service provided over a period.

On the other hand, billing in advance requires customers to pay before they receive the product or service. It’s common in situations where there are clear upfront costs, like event bookings, software subscriptions, or manufacturing.

Understanding the key differences between the two, such as their impact on cash flow and how they affect customer trust, can help you decide which method best suits your operations and choose the right tools to help you manage them.

Cash flow impact

When you bill in arrears, there’s a potential delay in receiving payments, which could strain your cash flow if not managed properly. You’ll want to set clear terms and follow up on any billing arrears to avoid past due invoices.

Billing in advance gives you immediate cash flow, providing more financial security. This is especially helpful in businesses that need to cover upfront costs, like buying materials or hiring extra staff.

Customer trust

When invoices are billed in arrears, you’re essentially trusting the client to pay after you’ve rendered the service. This method builds goodwill, as customers don’t have to pay until they’re satisfied with your work.

Billing in advance requires the customer to trust you, as they’re paying for a service or product they haven’t yet received. It works best when you have an established reputation or in industries where prepayment is the norm.

Billed in arrears vs. billed current

While billing in arrears means charging customers after services have been delivered, billing current (also known as billing in advance) involves collecting payment before providing the service. 

For example, billing current is common in:

• Subscription-based services
• Insurance premiums
• Rent payments
• Membership fees
• Retainer agreements

You’ll choose to bill in arrears when usage varies month to month or rinal charges depend on actual consumption. 

However, choose billing current when: 

• You need consistent cash flow upfront
• Your service requires significant initial resources or setup
• You want to reduce the risk of non-payment
• Your business model involves prepaid services or subscriptions

While billing current provides better cash flow management, billing in arrears may be more appropriate for variable services or building trust with new customers.

Pros and cons of billing in arrears

Payment in arrears offers several advantages that can help with relationship management and ensure accurate payments. Here are some key benefits:

• Building trust with customers: Clients appreciate paying after services are rendered, which fosters trust and long-term relationships.
• Increased accuracy in billing: You bill based on actual usage or work completed, avoiding estimates or miscalculations.
• Flexibility for service providers: Allows providers to offer more personalized services without needing fixed prices upfront.
• Avoiding miscalculations and inaccurate payments: You ensure accurate invoicing by charging for services after completion, reducing errors.

While billing in arrears has its perks, it also comes with challenges that can impact cash flow and business operations. Let’s look at some of the downsides:

• Delayed payments and cash flow issues: Waiting for payments can lead to cash flow challenges, especially for small businesses.
• Potential for nonpayment: There’s always a risk that clients may delay or fail to pay, requiring follow-ups.
• Impact on small businesses and service providers: Delayed cash flow can affect daily operations, making it difficult to cover immediate expenses.

Putting billing in arrears in place

Setting up a billing in arrears system involves several steps to ensure smooth implementation and effective management. Here’s how to get started:

• Define your billing terms: Clearly outline the billing cycle—monthly, quarterly—and payment due dates. Establishing transparent terms helps manage client expectations.
• Choose billing software: Invest in reliable accounting software, like QuickBooks, that allows you to automate invoice generation, track payments, and manage accounts receivable effectively.
• Create detailed invoices: Develop clear, itemized invoices that reflect the services rendered or products delivered, including the billing period, amounts due, and payment instructions.
• Communicate with clients: Inform your clients about the transition to billing in arrears. Clearly explain the benefits, such as increased flexibility and accuracy in billing.
• Monitor payments regularly: Utilize an accounts receivable aging report to track outstanding invoices and identify overdue payments. Regular monitoring helps you stay on top of cash flow.

How to use billing in arrears effectively

Effectively using billing in arrears involves careful consideration of several factors. Here’s what you should do to ensure you use it properly:

• Assess your cash flow needs and the nature of your services. If you provide ongoing services or variable pricing, billing in arrears may align better with your operational model.
• Consider whether your services are predictable or fluctuate significantly, as this can affect your billing approach.
• Review your accounts receivable aging report to understand customer payment patterns. If clients consistently pay on time, billing in arrears may be feasible.
• Identify clients with a history of delayed payments; upfront billing might be a safer choice for them.
• Research industry standards. Many service-based businesses, like plumbers and consultants, often use billing in arrears to maintain client satisfaction and trust.
• Understand how competitors handle billing; aligning with industry norms can enhance your credibility and client relationships.

Choose the best payment setup for your business

Choosing the right payment setup for your business is essential for maintaining a healthy cash flow and strong client relationships. Whether you decide to use billed in arrears, whether for a flat rate or hourly billing, understanding the pros and cons of each method will help you align your approach with your business needs. Take time to evaluate your industry, service predictability, and client payment behaviors to make an informed decision.

To simplify your invoicing and payment tracking, consider exploring midsized business software, like QuickBooks Online, to help streamline your processes, making it easier to manage accounts receivable effectively.