STARTING YOUR OWN BUSINESS

Understanding 'Paid in Arrears': Guide to Billing and Payment Practices

Published 12 Jun 20239 min read

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 advance payments and billing in arrears.

We take a look at what it means to pay or bill in arrears, the benefits and drawbacks, as well as best practices. Read on to find out more.

What does “paid in arrears” mean?

“Paid in arrears” refers to payments made after goods or services have been delivered. The financial term; “in arrears” means that a payment is behind, and 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.

“Paying in arrears means you make a payment after receiving a good or service.”

Whilst some arrears payments are agreed upon, “payment in arrears” can also refer to late payments. Common reasons for late payments include invoice errors or a dispute regarding the product or service. For agreed arrears payments, the terms should be laid out in your contract - this is often 30 day payment terms.

As a small business owner, paying for goods and services from your suppliers in arrears can help to ensure sufficient cash flow and offers a greater level of flexibility. It is a good idea to make sure you don’t have too many payments in arrears however as this can lead to errors and cause you to fall behind. Late payments could damage your relationship with suppliers, tarnish your businesses reputation and could result in additional fees and penalties, increased interest rates and inaccurate financial records.

One of the most common agreed arrears payment types is payroll.

“Payment in arrears” and payroll

Payroll in arrears 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.

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

The benefits of processing payroll in arrears:

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.

The disadvantage of processing payroll in arrears:

If you’re paying in arrears, that means employees won’t get their pay check immediately when they finish work. For those in certain industries, this can be frustrating.

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

Payroll taxes
Benefits and deductions, such as health insurance and retirement
accounts
Paid leave
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. 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 1st to 15th March, and you pay her on 20th March. 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 for the following pay period.

What does “billing in arrears” mean?

“Billing in arrears” is the process of invoicing customers for goods or services after they have been provided. 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 tap. 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.

Billing in arrears vs. advance payments: benefits and disadvantages

Both billing in advance and billing in arrears have benefits and drawbacks. Billing in arrears can often be the simpler choice for small business owners however.

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 being paid in arrears is that it reduces the risk of inaccurate payments. Billing in advance may require you to issue refunds if you accidentally 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 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.

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:

Conducting credit checks on clients to ensure they’re trustworthy and in good financial standing
Asking customers to make a downpayment to help manage cash flow
Having a system for following up on outstanding payments
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.

What to do if your arrears payment is late

In some cases, billing or paying in arrears can result in overdue payments. This typically happens when payments are recurring.

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

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, if 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.

As a small business owner, late payments can have a substantial impact on your cash flow. This could cause you to miss supplier payments or leave you unable to cover operating costs. To reduce the risk of overdue payments, you could send payment reminders, add a link to pay directly from the invoice when sent, or even look to introduce late payment fees as a deterrent to non-payment.

Read our guide on the pros and cons of charging late payment fees to find out more.

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.

Using an accounting software such as QuickBooks can help you to stay on top of payments, and accurately record incomings and outgoings.

When it comes to processing payroll in arrears, 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.

We hope you’ve found this article about arrears billing helpful. Our guide to starting your own business in the UK can help you grow your business further - simply fill out the questionnaire to find out where you’re at in your business journey and what your next steps are.

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