Avoiding the disruptions to your cash flow and accounts receivable caused by late payments comes down to having a plan that encourages prompt payments and deters clients from dragging their heels with your invoice.
A late payment fee is an amount added to the balance of an invoice when it isn't paid by the due date. Companies use late fees to compensate for the interest they lose when the money is not in their bank on time, and for the value of the time they spend dealing with overdue payments (monitoring the accounts and sending repeated requests for payment, for example).
As an independent contractor or business owner, you're legally permitted to apply late payment fees when clients miss a due date for payment. But you must first have a written agreement in place that outlines your late payment policies, and you'll need to keep your fees within the limits set by statutes in your state.
When a client misses a due date to pay for goods or services, you, the business owner, become a de facto creditor. You are extending credit to your client and giving them more time to pay their debt. Just as with any credit transaction, you must spell out the terms in advance and in writing in order to legally impose the added charge.
Your agreement should detail the fee for services and the due date for payment, usually written as, ‘net 30, 60, 90 days,' and so on (in business, ‘net' is a credit term that means the period of time allowed for paying an invoice. Net terms are calendar days). The agreement should state the late fee amount that will be added if payment isn't received by that date. Both you and your client must sign the agreement.
On the invoice you send to your client, you should clearly state your payment terms and late fee .
Your invoice should include:
The timeframe you set for payment is up to you and the arrangement you make with your client. The key point is to specifically state when payment is due in your agreement and invoice.
Before you set a late fee, it's important to understand the purpose of late fees. Under the law, you can't use a late payment fee to penalize or punish your client for not paying on time, or as a way to collect additional revenue. You can charge only an amount that covers the costs and losses you incurred as a direct result of the late payment, and those costs must be reasonable, such as:
Typically, late payment fees average 1% to 1.5% of the invoice amount. You can state the late fee as a percentage or a flat fee, so long as the amount you charge doesn't exceed your state's limits. Flat late fees are appropriate when you know the amount of the ultimate invoice at the time you sign the contract, because you can easily make sure that the fee doesn't exceed state law limits. On the other hand, if you will be paid by the hour and do not know in advance how many hours you will work, you'll have a hard time coming up with a flat fee that passes legal muster.
Though the amount allowed by each state varies, limiting your fees to a maximum of 10% per year should keep you from running afoul of state statutes.
Even when you keep your fees to the state maximum allowed, however, remember that fairness is key in determining late fees. If your client takes you to court to challenge the fees you've imposed and wins, you can end up paying many more times the fee in penalties.
Let's say you want your late fee charges to account for interest you would have earned had the invoice been paid on time. Follow these steps:
Here's an example based on an interest rate of 2%, and an invoice 30 days past due on an invoice total of $10,000:
.02 (the interest rate) ÷ 12 (months) = .0016 (monthly interest rate) x $10,000 (invoice amount) = $16.66 (the late fee).
If another month passes, and your client still doesn't remit payment, you'll have to add another $16.66 to the next invoice. Remember to detail the time the fee represents (30 days, 60 days, and so on) on the invoice.
The example above adds a simple interest calculation to the invoice charges, even though the balance on which you are charging interest will increase for each month payment is late. You can also compound the interest if state law allows it and your agreement so provides, as long as the sum owed does not exceed your state's annual limit or become unreasonably large.
While $16.66 might not seem a sufficient deterrent, adding any late fee can encourage your client to move your invoice to the top of the pile and pay it promptly.
Just because you are within your rights to charge clients who don't pay you on time, doesn't mean you should in every instance. Before enforcing your policy, consider whether charging the fee is worth jeopardizing your business relationship.
Try phoning your customer to discuss the reasons for the missed payment.
If your customer is a repeat offender, doesn't give you a reason for the overdue payment, or dodges your calls, it's time to put your late payment policy into motion.
First, check your service agreement or contract to make sure the amount you've calculated is consistent with the terms outlined for late payments.
Next, send a letter or email reminding your client when payment was due and the amount of the new balance including the late fee. Attach a copy of the original invoice, and explain that the late payment fee will be added for each month the invoice goes unpaid.
Include contact information and ask your client to contact you with any questions. You can also offer to set up a payment plan if you believe financial difficulties might be at the root of the overdue payment.
If you still don't receive payment, you should continue sending invoices with updated late fee charges. You'll have to decide at what point you move from invoicing to more formal collection methods. (See AllLaw's article, What to Do If a Client Won't Pay.)
It's a good idea to send your client a reminder (by telephone or email) about a week before payment is due. If the late payment was an oversight, a staffing issue due to vacations, or it was lost in a pile of paperwork, a reminder can jog the client into action.
You can also incentivize your client to pay early by offering a small discount, sometimes called a prepayment or cash discount. If your margins allow, consider offering a small percentage off the invoice for clients who pay within a shorter period than required. Make sure, however, that your discount isn't so large that it looks like you're trying to exceed the state limit on late fees when clients don't pay early. Courts might look at the difference between the full invoice amount and the discount amount and decide that the full amount was inflated to include a disguised, illegal late fee.
For example, if you require payment within 30 days, discount the balance by 1% or 2% if the customer pays within 15 days. Make sure that you document the discount in your service or purchase agreement and on your invoice to avoid misunderstandings about the terms.
Another option is to request pre-payment for services in full or part to reduce the impact of late payments on your cash flow.