Arrears billing and payments: What does it mean to be “paid in arrears”?

As a small business owner, you have a lot on your plate, especially when it comes to finances. Rent, utilities, payroll, inventory—these are just some of the expenses you’ll find yourself handling. With all of these expenses, it’s important to stay on top of billing, whether you’re paying employees or collecting payments.

The two most popular types of billing processes conducted by small businesses are billing in advance and billing in arrears. Simply put, billing in advance is collecting payments before delivering a product or service. Billing in arrears is collecting payments after providing a product or service.

But there’s more to arrears billing and payments than meets the eye. To give you a better understanding of what it means to be paid in arrears and how arrears billing works, we’ve created this guide. Read through to learn more about arrears billing, or use the links below to navigate throughout the post.

What is “paid in arrears”?

“Paid in arrears” means that payment for a service is provided after the service has been rendered. In the financial industry, “in arrears” means that a payment is behind. The term “in arrears” can be applied to both billing and paying. Billing in arrears means you bill customers after providing them with goods or services. Paying in arrears means you make a payment after receiving a good or service.

Employee payroll is one type of payment often paid in arrears. Arrears payroll means you pay an employee for work they completed in the previous pay period. This is in contrast to “current pay,” which is when an employer pays an employee the last day of the workweek. Using the current pay method, employers submit an employee’s hours for payroll processing before they even complete their work.

What does it mean to bill in arrears?

Billing in arrears means you charge customers after you’ve provided a service or good. For most small businesses and service providers, billing in arrears often makes the most sense. For example, if you’re a plumber, you will most likely ask for payment after you’ve fixed a clogged pipe or a broken faucet. Most customers don’t want to pay for a good or service beforehand, as they’d like to see the final result first.

Billing in arrears is often preferred over billing in advance because it can help businesses avoid certain miscalculations. For example, billing in arrears can prevent you from overcharging customers and having to issue refunds, or undercharging customers and having to process multiple payments.

Using arrears billing vs. advance payments: Benefits and disadvantages

While using arrears billing has plenty of positives, some negatives are worth noting. Take a look at the benefits and disadvantages of using arrears to help make your billing decision easier:

Benefits of paid in arrears billing

  • Accurate payments: The biggest benefit of paying in arrears is that it reduces the risk of inaccurate payments. Billing in advance may require you to issue refunds if overcharge a customer. If you undercharge, you may have to issue multiple bills.
  • Improved flexibility: Arrears billing is common in certain industries, and your customers or clients may not be comfortable with paying for a service upfront, particularly if the relationship is new. Clients may also appreciate the additional time before payment is due that arrears billing gives them.

Disadvantages of billing in arrears

  • Delayed payments: If you’re billing in arrears, your company won’t receive payments right away, which can hurt cash flow. Full or partial payment in advance, or progress payments throughout the course of a project may provide your company with working capital needed to complete work for your clients.
  • Risk of losing payments: By billing in arrears, you won’t receive payment until after you’ve provided a good or service. This increases the risk of a client failing to pay you because they don’t have enough money, they forgot, or they didn’t receive an invoice.
  • Chance of falling behind on payments: Balancing your budget should be a top priority. If you’re paying too many things in arrears, the chances of falling behind on payments can rise. Only keep a few payments in arrears, such as payroll, rent, and utilities.

Best practices for billing in arrears

If some of the drawbacks of billing in arrears make you skeptical, you may be wondering how to mitigate these disadvantages. Some best practices for billing in arrears include:

  1. Conducting credit checks on clients to ensure they’re trustworthy and in good financial standing
  2. Asking customers to make a downpayment to help manage cash flow
  3. Having a system for following up on outstanding payments
  4. Using QuickBooks accounting software  to send invoices, collect payments , and manage payroll

By staying on top of payments due and payments owed, you can conduct arrears billing with ease to avoid any unnecessary errors or discrepancies.

Arrears payments

Arrears can also refer to payments a company owes. You may make payments to vendors in arrears, and you may also pay your employees in arrears.

It’s a good idea to avoid having too many payments in arrears. When this happens, it can be easy to fall behind on your payments and make errors on your financial records. Below are some common questions covering arrears payments, why companies might pay in arrears, and the problems with overdue payments.

Why do employers pay in arrears?

Most companies pay in arrears because it reduces confusion when processing payroll. Paying in advance can result in overtime hours, PTO, or sick leave being miscalculated. This can disrupt a business’s cash flow and leave an employee with a paycheck made out to the wrong amount.

reasons companies pay in arrears

Here are a couple benefits of using arrears payment for payroll processing:

  • Arrears payroll payments give you time to accurately record employees’ hours. With the current pay method, you may be inputting an employee’s hours while they’re still working. This can lead to inaccuracies and frustration down the line.
  • Paying in arrears also ensures employees complete the work they’re responsible for. When paying in advance, you could end up paying for incomplete work.

A few potential disadvantages to consider:

  • If you’re paying in arrears, that means employees won’t get their paycheck immediately when they finish work.

Paying in arrears is often much easier to process

As you process payroll, several factors need to be considered, including:

  • Federal and state tax withholdings
  • Payroll taxes
  • Benefits and deductions, such as health insurance and retirement accounts
  • Paid time off (PTO)
  • Sick leave
  • Tips
  • Commissions and sales earned
  • Overtime hours

Paying employees after they’ve performed work is much easier to process, as it gives you time to consider these factors when processing payroll. Depending on your payroll schedule, whether it’s weekly, biweekly, monthly, and so forth, wages are scheduled after the payroll period.

Let’s look at an example. Say Jill works from March 1 to 15, and you pay her on March 20. In this scenario, you would be paying her in arrears. Paying in arrears doesn’t mean the payment is late. It only becomes a late payment if you fail to make the payment by your payment contract’s due date. Paying at the end of the period gives you time to secure financing, such as through sales or by processing accounts receivable, to pay your employees.

On the other hand, when employees are paid in current, it can make processing payroll more challenging, especially for commissioned and hourly employees. Because there’s no gap between the end of a pay period and the day employees get paid, employers will have to predict employee hours. For example, if a workweek is Monday through Sunday and you pay employees every Friday, you’ll have to process payroll early. You’ll then have to project what an employee will work on Friday, Saturday, and Sunday. If they take a sick day or work overtime one of those days, they will be overpaid or underpaid for that pay period. This will then need to be adjusted the following pay period.

At the end of the day, whether you choose to pay current or in arrears, it’s essential to pay on time and accurately. It’s also important to comply with local, state, and federal labor laws when processing payroll.

“Arrears” in the context of overdue payments

In some cases, billing or paying in arrears can result in overdue payments. This typically happens when payments are recurring, such as ordinary annuity payments, child support payments, mortgage payments, car loan repayments, and so forth. With recurring payments, payments are usually made on a set schedule without much work needing to be done on both the giving and receiving end. This is because payment software handles most of the work.

However, there are numerous reasons why late payments might happen, such as:

  • The customer never received an invoice
  • The invoice wasn’t recorded properly by the customer
  • The customer didn’t record the accounts payable in their payroll system
  • The customer failed to pay
 reasons why late payments might happen

When a payment in arrears fails to go through by the payment due date, it becomes an overdue payment. This means the next payment is in arrears.

For example, let’s say you have recurring payments to your landlord for rent, and $3,000 is taken out monthly for your commercial property space. Your May and June payments go through fine, but for some reason, July’s payment isn’t recorded or collected. You then continue making on-time payments for August. Because you didn’t make the July payment, August’s payment is in arrears. That’s because the August payment was used to cover the missed July payment. To catch up on a missed payment, you will typically have to make two payments.

Paying in arrears on accounts payable: Consequences of late payments

Accounts payable refers to the money a company owes to its creditors. If you’re paying in arrears on accounts payable, making these payments on time is crucial. If not, these late payments can face some consequences, such as increased interest rates, negative cash flow impacts, payment term restrictions, poor relationships, negative reputation, and inaccurate financial records.

These are just some of the consequences that can come with not paying your vendors on time. To keep your business in good standing, make sure to make your payments in full and on time.

Consequences of late payments

How to manage payments in arrears

Billing in arrears allows you to collect a customer’s payments after you’ve provided a good or service. However, since you’re collecting payment after something’s been provided, managing payments can get tricky. To manage payments in arrears, it’s important to track expenses and income. Doing so will help you manage cash flow and look at what payments are owed to you and what payments you owe to creditors.

When it comes to paying in arrears and payroll, using payroll software lets you set a payment schedule that works for your business. Not only will you be able to set payroll to run automatically, but you’ll also be able to calculate and file payroll taxes, manage HR and employee benefits, and more. QuickBooks is your all-in-one solution for your accounting, payment, and payroll needs.

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