How Much Interest Can I Add to an Overdue Invoice? Late Fees Explained
There is no standard interest rate charge for an overdue invoice. This charge, known as a “late fee”, is up to the vendor. However, in order to avoid conflict, best practices would dictate that the late fee has already been agreed to, in writing, by the client, before work commences.
Here’s What We’ll Cover:
What Is a Late Fee?
A late fee is an additional charge a vendor adds to an unpaid invoice. This is done when the payment terms on the invoice have not been met.
Payment terms refer to the length of time a vendor has given the client to pay an invoice. The most common payment terms are “payable upon receipt”, “net 30 days”, “net 60 days” and “net 90 days”. For small businesses, “net 30 days” is the standard.
Payment terms and late fee information are typically included on an invoice.
What Is the Standard Late Fee on an Invoice?
There is no ‘standard’ late fee because such charges are not regulated. A late fee can be a flat rate, or as is more common, a monthly percentage of the overdue amount.
Small business owners need to weigh late fees against the possibility of future business with the client who is late with the payment. A vendor should always follow up on an overdue invoice, but should also consider that the addition and insistence on a late fee may potentially damage the working relationship.
When Can You Charge a Late Fee?
Technically, a vendor can charge a late fee anytime after payment is due. For instance, if a vendor’s invoice is due in 30 days, a vendor can start charging any time after those 30 days have expired. However, a vendor should allow a grace period between the 30 days and when actually applying the charge. The amount of time should be based on the vendor’s existing relationship with the client, the amount of the invoice, and the possibility of future work.
This grace period is important for a number of reasons. First, if the payment is actually on the way, the vendor is going to be seen as unprofessional charging an additional amount so soon. The client may have had the best of intentions to pay an invoice on time, but for any number of reasons payment may have been delayed. By allowing a buffer, it shows the client that the vendor is reasonable.
Second, the extra amount is unlikely to be worth the effort. Let’s use an example.
Pat’s Pastries is a store in Columbus, Ohio. Every week, five times a week, she delivers pastries to Ian’s Investors, an investment firm about five minutes from her store. The pastries are for staff and clients.
The weekly amount is $200.00.
At the end of the month, Pat submits an invoice for $800.00. The payment terms indicate payment is due in thirty days.
The thirty days goes by and no check. Now, Pat’s policy is to charge an 8% monthly late fee on overdue invoices, to discourage late payments. This means that for every thirty days this invoice remains unpaid, she can charge $64.00 per month, or $2.13 per day.
Now the question is, when should Pat start chasing her money? She’s very busy, but her enterprise is not huge, and the $800.00 owed matters to her. The $2.13 daily charge, even if collected, won’t make a difference to her business. At least, not short term.
Best practices would state that, for Pat, she should make a courtesy call a day or so after day 30, to her direct contact, which is Ian. Pat does this, only to discover that Ian was sick for a week, right around the time she emailed her invoice. Then he was out of the country on business for ten more days, and as such her invoice was seriously delayed going to accounting. However, Ian has promised to look into it. He calls back that afternoon and tells Pat he has put a rush on it, and apologizes for the inconvenience. She gets the check within 48 hours.
Now, let’s say that’s not the reception that Pat receives. Let’s say she called but didn’t get to talk to Ian, so she leaves a polite message asking him to call her back about the missing payment. In her message, she also lets Ian know she will re-forward the invoice, which she does in an email that afternoon. Nothing happens, and in the weeks that follow, there is still no payment. At this point, Pat has done all she can. At the end of the 30 days, she applies the interest charge and resubmits the invoice.
Can You Legally Charge Interest on Overdue Invoices?
Yes, there is nothing stopping a vendor from charging interest on overdue invoices. The practice is legal. However, the real question is whether the clients are obligated to pay it.
If a vendor doesn’t have an agreement with a client on the payment terms and late fee, then that means the client doesn’t have to pay it. So, it’s best for a vendor to include these details in a contract, before the start of work. This way the management of both the vendor and client companies know the expectations, and there are no surprises later.
Take Pat’s Pastries. When Pat was first contacted by Ian, she had him fill out an order form. The order form required Ian’s signature, and the form specified that “payment terms are net 30 days, subject to an 8% monthly late payment fee”. Pat had implemented this late fee policy when she first opened the company for business.
It’s in bold font, at the bottom of the order form.
By signing and emailing the form, Ian has committed to these conditions. In other words, Pat has a strong case if she has to take him to court in order to get the money owed her.
Sometimes the late fee will be paid simply so the client can continue working with the vendor, without bad feelings. Let’s say Ian is not the greatest with paperwork, and when he finally catches up on it all about a month later, he realizes he not only owes Pat for a month of pastries, but a late charge as well. And now there’s a new invoice too for the latest month.
Ian knows that he can fight the late charge and that Pat would probably drop it just to keep the business, but chooses not to. He knows he’s late, and he also knows that fighting it with a client who has always delivers excellent product, and on time, may not be the best idea. And, the late fee was included on the order form, which he signed. So, he is obliged to pay it anyway, from a legal standpoint. So, he does, right away, and the business relationship continues.