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Customers not paying? Here's how to recoup your funds by charging interest and late fees on unpaid invoices.
You held up your end of the deal by rendering services or delivering goods. However, your client is ignoring the invoice. It’s an unpleasant situation with implications for your cash flow, accounts payable process and customer service. You’ve sent second notices, statements or demand letters, but nothing is working. How can you collect past-due invoices effectively and prevent late payments in the future?
The answer is making late payments painful for the client by charging late fees or interest on unpaid balances. These charges help alleviate cash flow problems and reimburse you for collection efforts. It also incentivizes clients to pay on time to avoid paying more for their procrastination.
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An interest fee is additional money the client owes you over and above the original invoice amount if they pay late. The interest rate is a percentage of the unpaid balance that accumulates every month the invoice remains unpaid. The interest rate usually is displayed as an annual rate, for example, 10 percent. But since it accrues monthly, the amount charged is that annual rate divided by 12. So, a 10 percent annual interest rate would be 0.83 percent each month.
Interest fees usually compound to serve as a more substantial disincentive for late payments. This means that if the interest is charged in month two, it’s added to the balance due. If the customer still hasn’t paid by month three, the monthly rate is applied to the new balance.
For example, let’s say you invoice a client $200 with net 30 terms. The first month comes and goes with no payment. Now, you would apply the 0.83 percent to the $200 balance:
$200 x 0.0083 = $1.66 This is the interest fee for month one.
At the end of month two, the customer now owes:
$200 original balance + $1.66 interest = $201.66
If the customer does not pay in month three, the interest is applied to the new balance:
$201.66 x 0.0083 = $1.67 interest
At the end of month three, the customer now owes:
$201.66 + $1.67 = $203.33
Since the interest fee is based on the amount owed, the penalty amount keeps increasing the longer it remains unpaid. While it doesn’t look like much, interest fees can accumulate quickly, especially if the original invoice amount is significant. Customers will feel pressure to pay as they see the amount owed ballooning.
Late fees are another financial penalty for late payment. Instead of multiplying the balance by an interest rate, you would charge a flat amount when a payment is late. Most late fees are between $25 and $50. For example, you may charge a late fee of $25 when an invoice is not paid according to the terms. Some companies use a percentage of the invoice amount to calculate the late fee, but this amount does not compound as it would be the same amount each time.
If the customer continues not to pay, you can assess multiple late fees as long as these terms were laid out in your written agreement before the sale and on your invoices. They must also comply with state law. You can also set the frequency at which late fees will be assessed, such as daily, weekly, monthly or quarterly. State laws often cap the total amount of allowable late fees, which are usually tied to the invoice amount.
Since late fees are generally larger amounts that accumulate more quickly, they can be a stronger incentive for prompt payment than interest fees. For example, on the same $200 invoice as outlined above, a monthly late fee would work as follows after the first month of nonpayment:
$200 original invoice amount + $25 late fee = $225 new balance at the end of month two
If the customer does not pay in month three, another late fee is assessed:
$225 balance + $25 = $250 new balance at the end of month three
However, if your state law caps interest and late fees to no more than 10 percent of the original invoice, it is better to go with interest fees. This is because $50 in late fees is more than 10 percent of $200 and charging this would be illegal.
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 primary objectives.
When charging a late fee or interest, ensure the original contract the client signed states any fees or interest charges that will be assessed, when they will be assessed, whether they compound and if there is a grace period. A grace period is a time after the invoice is due in which you don’t charge interest or fees as long as payment is made in that window. For example, if an invoice is due on the first of the month, the grace period may be an additional 10 days. That way, you avoid alienating your client if payment is just a few days late.
There are three essential things to know about charging interest and assessing late fees:
Do charge interest or late fees when:
Don’t charge interest or late fees when:
Some states have laws setting a maximum amount for late fees that businesses can charge; others require you to give debtors a grace period before charging late fees. Here’s a state-by-state breakdown:
State | Late fee limitations |
---|---|
Alabama | No maximum late fee; seven-day grace period |
Alaska | No maximum late fee; seven-day grace period |
Arizona | No maximum late fee; five-day grace period |
Arkansas | No maximum late fee; no grace period required |
California | No maximum late fee; no grace period required |
Colorado | No maximum late fee; no grace period required |
Connecticut | No maximum late fee; nine-day grace period |
Delaware | 5 percent per month maximum; five-day grace period |
Florida | 5 percent of past due amount maximum; 15-day grace period |
Georgia | No maximum late fee; no grace period required |
Hawaii | 8 percent per month maximum; no grace period |
Idaho | 5 percent of past due amount maximum; 10-day grace period |
Illinois | Maximum of $20 or 20 percent, whichever is greater; no grace period |
Indiana | No maximum late fee; no grace period required |
Iowa | Maximum of $60 per month for balances under $700 and $100 per month for balances over $700; no grace period required |
Kansas | No maximum late fee; no grace period required |
Kentucky | No maximum late fee; no grace period required |
Louisiana | No maximum late fee; no grace period required |
Maine | Maximum of 4 percent per month; 15-day grace period |
Maryland | Maximum of 5 percent per month; 15-day grace period |
Massachusetts | No maximum late fee; 30-day grace period |
Michigan | No maximum late fee; no grace period required |
Minnesota | Maximum of 8 percent per month; no grace period required |
Mississippi | No maximum late fee; no grace period required |
Missouri | No maximum late fee; no grace period required |
Montana | No maximum late fee; no grace period required |
Nebraska | No maximum late fee; no grace period required |
Nevada | Maximum of 5 percent per month; no grace period required |
New Hampshire | Maximum of 5 percent per month; no grace period required |
New Jersey | No maximum late fee; no grace period required |
New Mexico | Maximum of 10 percent per month; no grace period required |
New York | Maximum of $50 or 5 percent per month; five-day grace period |
North Carolina | Maximum of $15 or 15 percent per month; no grace period required |
North Dakota | No maximum late fee; no grace period required |
Ohio | No maximum late fee; no grace period required |
Oklahoma | No maximum late fee; no grace period required |
Oregon | Maximum of 5 percent per month; no grace period required |
Pennsylvania | No maximum late fee; no grace period required |
Rhode Island | No maximum late fee; no grace period required |
South Carolina | No maximum late fee; no grace period required |
South Dakota | No maximum late fee; no grace period required |
Tennessee | Maximum of $30 or 10 percent per month; five-day grace period |
Texas | No maximum late fee; five-day grace period |
Utah | No maximum late fee; no grace period required |
Vermont | No maximum late fee; no grace period required |
Virginia | No maximum late fee; five-day grace period |
Washington | No maximum late fee; no grace period required |
Washington, D.C. | 5 percent per month maximum; five-day grace period |
West Virginia | No maximum late fee; no grace period required |
Wisconsin | Maximum of $20 or 20 percent per month; five-day grace period |
Wyoming | No maximum late fee; no grace period required |
There are other ways to collect your invoices besides charging interest and late fees. Additional options include:
Interest and late fee charges are viable collection tactics that speed up the debt collection process and compensate you for the costs of interrupted cash flow and additional collection activity. But be sure to do it correctly, or you could alienate customers and get in trouble with the law.