Late payment is a common problem for small businesses. How often have you completed the work, sent an invoice and waited weeks, if not months, to get paid? Or at least heard of stories like this?
Late payment is tough in normal times, but especially when times are tough. Not only does it become a financial burden, but an emotional one too.
A common solution to deal with late payment is to charge a late payment fee. It’s the obvious solution, right? You give the client a push to pay you now, or they incur more costs further along the line.
But is it that simple? Are there not situations where it’s a bad idea? And once you’ve decided to charge a late payment fee, how much do you charge? There, is, in fact, a lot to consider. In this post we’ll explore it all:
- Why charging a late payment fee is a good idea
- Guidelines for charging these fees (and when it may be a bad idea)
- How much to charge
Why Charging Late Payment Fees Can Be a Good Idea
Besides encouraging clients to pay, an overdue payment fee is a good idea for several other reasons:
- You need the money – ASAP. In tough times, cash flow is especially important. Late payment fees can be an added incentive to get clients to pay you, sooner. While ideally, you could avoid such measures, the mere idea of late payment fees might motivate clients to pay you as soon as they can, or at least communicate with you if they’re unable to.
- It establishes you as a serious professional who has a business to run. If you don’t include a late fee policy, the perception may be that a client who doesn’t pay on time can repeat this behavior.
- You get paid before other contractors do. The chances are that if that client isn’t paying you on time, he’s doing the same to other contractors. But if you have stricter payment policies and kick up a fuss, they’ll move your payment to the top of the pile.
While in principle, late payment fees work, there are instances when they’re not a good idea.
Guidelines for Charging Late Payment Fees
By following the below guidelines, you’ll better understand when it’s suitable to charge these fees.
1. Ask Yourself: Did the Work Fulfill the Estimate?
Clients are different. Some won’t pay you because, well, they’re bad clients. Others, still, won’t pay because they don’t have the money. But then there are those who aren’t happy with your service. But, instead of kicking up a fuss, they vent their anger by not paying you on time. They’re passive-aggressive.
Include a late payment fee in an invoice, only aggravates the problem. That’s why it’s important you check that the work fulfilled the estimate before you invoice. If it did, the client is most likely satisfied. You can now send your invoice and include payment terms so that there are no surprise late fees. Speaking of which…
2. Ask Yourself: Are Clients Aware of the Fee?
Nothing burns bridges faster than surprise charges. Don’t include late payment fees if clients aren’t expecting any. Rather, first establish expectations by:
- Specifying the fee early on in the relationship, in writing, ideally through a contract.
- Specifying the fee on all invoices you send. Make sure it’s visible; don’t hide it in the fine print. In the same way, you get frustrated when you encounter surprise fees, buried deep in the terms and conditions, so to do your clients.
Where you have not specified the above, you can still include late payment fees. Just inform the client in advance, stating that next month you will have a late payment policy. This way they can’t act ignorant to the fact and can expect all future invoices that are unpaid – after a certain amount of time – to increase in value.
And if the client responds, asking for justification, you can say that it is, in fact, a policy you enforce (or will be enforcing) with all new clients.
3. Know When Forgiveness and a Softer Touch is the Better Choice
Just because you have a late fee policy doesn’t mean you have to enforce it on every occasion. For example, a client may be going through a personal challenge – like dealing with bereavement, or they’re hit hard by the current recession. In other cases, there may be unforeseen circumstances where a lucrative and usually reliable client can’t pay you on time. Evaluate each situation and don’t impose the same policy on everyone.
By highlighting that you’re empathetic with their circumstances and waiving the fee, you can strengthen your relationship with them. This will only contribute toward business success in the long run. Besides good business practice, it pays to be human.
How Much Should You Charge?
Let’s assume you’re considering charging a late fee, the next questions you probably have is: How much do I charge? How do I calculate the interest fee? Is there an upper limit? What’s acceptable and what isn’t?
Before we move on to answering these questions, it’s important to reinforce that the purpose of the late fee is to motivate timely payment and NOT to create an extra revenue stream.
So, make the fee sufficient enough for people to act, and not too exorbitant that the client feels you’re hauling them over the coals (especially if the payment is only a day or two late). If anything it’ll only sour the relationship and you’ll lose their business.
Okay with that out the way, let’s get back to it.
The first step is to establish an acceptable level of interest to charge. In the States, for example, there are different laws for each state. Familiarize yourself with those.
Once you know what the maximum annual interest rate you can charge is, work out the monthly finance charge. Just divide the state’s max. by 12. For example, if the rate is 18%, the monthly finance charge is 1.5% (18/12). On a $5000 invoice that is 30 days late, a penalty of $75 ($5000×0.015) applies.
Let’s also assume that the payment is 15 days late. It becomes a little different. Then you can calculate the charge by dividing 15/365, multiplying by 18%, and then by the total on the invoice. It gives you roughly $37.
It’s as simple as that…and charging a late fee with FreshBooks is even simpler. When you create an invoice and add a client, you have the option of setting late fees, either as a percentage or a flat fee.
For more information read What are Late Payment Fees and Reminders?
This post was updated in November 2020.