Should I charge interest on overdue accounts?
28 October 2019
There are many reasons to charge interest and late fees on overdue accounts. Primarily it is used to discourage customers from “borrowing” from your company instead of using traditional forms of capital such as bank financing or their reserves. If the customer is going to be late paying their debts to you, it is helpful to receive some compensation for the use of your money.
If you decide to charge interest on your overdue invoices, several things must be followed in order for your claim for interest, and any other fees to be legally enforceable. First, the customer must be made aware of any extra fees you intend to charge over and above the pre-determined cost of your goods or services. Disclosure can be accomplished in the “Terms and Conditions” section of your credit application or your written agreement for services. Your customer must acknowledge, in writing, that you intend to charge interest and any other fees on past due invoices.
Second, you must disclose the exact amount of calculating interest on overdue invoices. Some calculations are simple interest, while others may compound the amounts charged. There is no right or wrong method; however, if you need to have the court system involved to receive compensation, your way of calculation must be disclosed in your credit application and correctly presented on all invoices. For example:
- “Interest is charged on all invoices which are 30 days past due at a rate of 1% per month, or 12% per annum”. This is an example of simple interest.
- Whereas “If customer does not make payment within 30 days of invoice date a finance charge of 2% per month (an effective annual interest rate of 26.84% per annum) may be charged to the customer. Calculation of finance charge would begin on the 31st day following date of invoice,” which is a sample of how to disclose compound interest.
Lastly, your invoices must contain the disclaimer to remind your customer about the agreed charging of interest on overdue invoices. Review your invoices to determine if they provide the interest disclosure. If not, all accounting software has settings that can be edited to correctly calculate and charge interest as well as disclosing this on invoices.
If you don’t ask, you don’t get
Be consistent with charging interest on your overdue invoices. The customer has acknowledged the added fees and has elected to be late in paying its obligation to you. All interest collected is to compensate you for the use of your money. Perhaps you are using an operating line of credit with your bank – if so, it costs you money every day you must wait to receive payment from your customer.
Many firms use the interest charge as a negotiation tactic to get paid. “If we receive your payment today, I will waive the interest which has accumulated on your account.” Sometimes you may receive short-paid invoice payments where the customer has unilaterally changed the terms of the credit agreement and remitted the principle and taxes only, ignoring your interest charges. In these circumstances, we recommend meeting with your customer right away to discuss your terms and conditions. If you don’t have this discussion, then you are sending the signal to your client that the interest charges are unimportant to you, and that it is okay not to pay on time.
This article was developed to help you effectively charge interest on overdue invoices. By following this method, not only will your claim for interest through the courts will be granted (in the unfortunate instance where you have to sue to collect), but also allowing you to set clear expectations with your customers about your credit-granting policies. It is your money out there. For every day your customer is late paying its bill to you, you are unable to use your own money to pay debts, make payroll, or buy new raw materials. Don’t be shy – if you don’t ask, you don’t get.
Blog post submitted by Chamber Member Priority Credit Management Corp