Customers not paying? Here's how you can successfully charge interest and late fees on unpaid invoices.
You held up your end of the deal – rendering services or delivering goods – but now your client is ignoring the invoice. It's an unpleasant situation, with implications for your cash flow and customer service. You can charge a late fee or interest, but make sure the original contract the client signed clearly states any fees or interest charges that will be assessed.
There are three important things to know:
- Assess late fees only if a written agreement outlines this option. Be sure to include this phrase: "Accounts not paid within terms are subject to a ___% monthly finance charge."
- Don't charge more than 10% interest per year. Some states restrict the amount you can charge in late fees, but you're likely safe if you cap rates at 10%.
- Try waving a carrot instead of a stick by offering a discount for either full payment upfront or within 30 days. Sometimes incentives to pay early or on time can be more effective than threats of fees and interest charges.
Knowing the answers to a few key questions and taking action upfront can ease the pain of dealing with non- or slow-paying customers.
Can you charge interest on unpaid invoices?
You can charge interest on unpaid invoices if you stay within the bounds of the law. Late fees are standard practice in many industries. Nevertheless, you should let your client know your intention in advance. The key to charging interest is to do it legally and without losing sight of your goals. Collecting the original invoice amount and maintaining a good relationship with the customer should always be your main objectives.
Editor's note: Looking for a collection service? If you're looking for information to help you choose the one that's right for you, use the questionnaire below to provide you with information from a variety of providers for free:
What do you put on an invoice for payment terms?
Payment terms should clearly state when the invoiced amount is due and what prompt payment discount you offer, if any. These terms should be on your customer agreement and every invoice.
Also, whether listed with your payment terms or elsewhere on your invoice, be sure to let your customer know how they can make payment. If you accept credit card payments online, include that information.
Remember that payment terms and late fees are two separate things. The terms should state when you expect to be paid and what incentive, if any, you offer for prompt payment. Your late fee statement is a way to let your customer know the penalty for missing that invoice due date. Language regarding penalties for late payment should be straightforward. At a minimum, both the contract and invoice should state, "Accounts not paid within terms are subject to a ___% monthly finance charge."
Whatever you put on your invoice should echo the wording on your original contract or customer agreement. [See our article on how to write an invoice.] While no one begins a business relationship or transaction with the expectation of late payment, the time to protect yourself is at the outset.
Whether you hire an attorney or use one of the many templates available online, be sure to write a clear customer agreement that will prevent misunderstandings. Repeat your payment terms on every invoice.
How long should you give someone to pay an invoice?
The amount of time you give someone to pay is an important component of your payment terms and can vary greatly. Payment terms can range from the immediate "due on receipt" or "net-10 days" to "net-90" or "net-120." In many industries, 30-day terms are most common.
How long you give a customer to pay represents an opportunity to customize your business agreement to their needs. If your customer is doing business with a government agency or working on a large project where they will receive progress payments, they may need more time to pay. If your cash flow allows you to extend longer terms without detriment, this may be a way to win a customer, even if your price is higher. A potential downside to longer terms is that if there is a problem (for example, your customer is unable or unwilling to pay), the debt can pile up before you are aware of the issue.
A conversation with your customer during the contract phase will allow you to agree on terms that work for both of you. If your customer is never going to be able to pay in 30 days, knowing when they will be paying – even if it's not for 90 or 120 days – will allow you to budget and keep a handle on your cash flow.
Should you charge late payment fees on invoices?
There is very little downside to adding a section on late fees to your contract and invoice. It's there if you need it and will cause no harm if you don't. Most clients, especially those who pay on time, will understand the inclusion of a late fee or interest provision.
A statement regarding late fees underscores your professional credibility and prevents surprises for the small number of instances you need to charge them. In fact, in some cases, agreeing to forgive late fees can help you collect late money.
When should you charge a late fee to a customer?
The short answer is that you should charge a late fee when it will get you paid without destroying the customer relationship. While potential late fees may make some customers move your invoice to the top of the pile, there is a more positive way to achieve the same outcome. Terms that include a prompt payment discount have the potential to improve your cash flow. An example of this wording is "2/10 net 30," meaning the customer receives a 2% discount for payment within 10 days, with the entire (net) amount due at 30 days.
Whether you actually demand payment of a late fee is a business decision you should make on an individual basis. Is there a reason for nonpayment, such as an issue with the product or service that needs to be addressed? Are there extenuating circumstances for the customer? If so, a conversation and an agreement to slower payment or a waiving of late fees could cement the customer relationship.
Perhaps longer terms – 60 or 90 days – work better for your customer. If waiting is not going to put a big crunch in your cash flow, that accommodation may be the solution. Remember, late fees on invoices should not be considered income generators; they are protection for your cash flow.
How much can you charge for late payment of invoices?
Once you've made the decision to charge a late fee, you need to decide on the correct percentage. There are laws on the maximum you can charge in late fees. These caps on late fees have serious legal implications, and they vary from state to state. You can find detailed guidance online. Keep in mind that the rate on your contract and invoices should be a monthly rate.
If you are having a standard contract drawn up, your attorney can help with the correct percentage and wording. If you ever end up in court and the payment terms are not spelled out correctly, your entire contract could be nullified. [Need help collecting late payments? Consider a collection agency service.]
What is the standard late fee on an invoice?
The standard late fee is different from the maximum legal late fee. Standards vary by industry, so it is helpful to find out what others in your field charge. Many businesses include a 1% or 1.5% monthly late fee in their wording. Remember, the wording on the invoice should match the wording on the contract or sales agreement and should state both the late fee percentage and the due date.
How do you calculate late fees on an invoice?
Once you have determined the correct percentage, good accounting software will calculate finance charges for you and automatically add them to your invoices.
If you are invoicing manually, you can find a simple daily interest calculator and a monthly compounding interest calculator at the U.S. Bureau of the Fiscal Service. Alternatively, you can create your own spreadsheet to do the calculation.
Tips for charging interest and late fees
The following tips can help you successfully charge interest and late fees on outstanding invoices without putting a significant burden of additional labor on your shoulders.
Select software with built-in templates for charging fees and interest. Install software that not only has invoices but will compute late charges for you.
Use the right forms that include agreement to pay interest. A promissory note is a written promise to pay money that is owed. This is written evidence of the debt and the terms under which it will be paid, including any interest or late fees.
Send a demand letter. If someone owes you money and gets behind on the payment plan, work out a new one. If that doesn't work, send a demand letter. Don't threaten to take action in this letter – for example, threatening to sue in small claims court – unless you really intend to do it.
- Use calculators to figure out interest rates. Late fees are usually assessed as a monthly finance charge.
- To calculate late fees, first decide on the annual interest rate you want to charge, then divide that by 12. Next, multiply that monthly rate by the amount due to arrive at the monthly late fee. Example: You have a 12% late fee on a $10,000 project. Divide 10,000 by 12 and get a monthly interest rate of 1%. Then multiply 1% by 10,000, and you arrive at a $100 monthly late fee.
- Will clients really pay late fees and interest charges? Most small business owners dealing with slow-paying customers would be happy just to get paid, but documenting a paper trail that can be used as evidence in small claims court – and then threatening to take the client to court – can convince most customers to pay the whole bill, fees included.
Mary Sit contributed to the writing in this article.