Should You Charge Interest Or Late Fees On Overdue Invoices?

Most business owners know the feeling. You’ve done the work, you’ve sent the invoice, and the due date has passed with no sign of payment. 

You don’t really want to chase customers to pay invoices because you’ve got better things to do. A LOT of better things to do.

So you ask yourself – what can I do to encourage customers to pay on time? Would some sort of late fee help to prevent late payment on invoices?

The answer: yes. Late fees or interest can be effective, BUT you need to go about implementing them the right way…

TL; DR

Charging interest or late fees isn’t a guarantee that customers will pay invoices on time, but it can help. You need to charge an appropriate amount and tell customers about it in advance. 

Impact of late payment on businesses

Small to medium sized businesses are particularly vulnerable to the effects of customers not paying invoices on time. Overdue invoices create cash flow issues that can be hugely damaging. In fact, 82% of businesses that fail do so because of cash flow issues.

As a small business owner, navigating late invoice payments isn’t really something you want to be doing. Business owners are notoriously time-poor, and to waste time chasing up a customer for a long overdue invoice just means you’re not focusing on something else that actually needs doing. 

This is where the question of charging interest for late payment comes in. 

Charging interest or late fees on overdue invoices: Is it worth it?

Charging interest on overdue invoices can help with a few different scenarios:

• You need the money. Cash flow is a genuine challenge that business owners struggle with all the time. Businesses have their own expenses and overheads to pay, and you rely on money coming in to cover them. By incentivising customers to pay on time, you relieve yourself of cash flow pressure.

• Repeat offenders. Some customers are worse than others when it comes to paying invoices on time. By charging interest on overdue invoices, you set a standard and show them you won’t muck around when it comes to this kind of behaviour. 

• Cutting the queue. If a customer isn’t paying you on time, they may well be doing the same to others. When they have multiple bills to pay, they’re likely to prioritise the ones that charge late fees.

• Protect yourself. If you do need to bring in debt collectors to enforce payment, the cost of this can be passed to your customer. If you have not included this in your terms of trade, you will be stuck with the recovery costs, typically 20-30% of the invoice.

But what about the disadvantages of charging interest on overdue accounts? There are two main points to consider.

• It may not actually work. If a customer is going to be tardy in paying their bills, there’s no guarantee that a late fee will actually get them to pay on time. In this instance, charging them extra may not go down well.

• It may impact customer relationships. If customers are good to do business with, albeit with the occasional late invoice payment, it may not be worth charging interest if there’s a risk it’ll ruin the relationship.

Charging a late fee is one of a few different levers you can pull when chasing overdue invoices. It helps to consider all your options.

How much should you charge for overdue invoices?

If you decide that a late fee is worthwhile, the next issue is how much to charge. It shouldn’t be excessive, but it needs to be enough to encourage prompt invoice payment.

Generally, interest on invoices should be no more than 10% annually. Be careful not to confuse that with a charge of 10% of the invoice value. 

For example, if you charge 10% interest on a $10,000 invoice, that’s $1,000 for the entire year, or $83.33 per month.

If you opt for a straight late fee, a fee of between 1-1.5% of the value of the invoice is the general standard. 

Is there a difference between interest and late fees? Ultimately, it doesn’t really matter what you call it. As a term, late fee does carry a bit of sting that puts the onus back on the customer to avoid it. 

Tips to successfully implement late payment fees/interest

If you decide to implement a late payment fee, it’s important to tell your customers about it. This is for two reasons:

• It’s a legal requirement. Businesses can’t just spring late fees on customers without prior warning. 

• It’s good relationship management. Communication is a cornerstone of any relationship, so customers should know late fees are possible if they don’t pay invoices on time.

Remember, the whole point of a late fee is to encourage customers to pay your invoice on time, so you don’t have to chase overdue invoices. In order to achieve this goal, customers need to know they can be charged extra if they’re late.

Read more: Tips for dealing with consistently late paying clients

How should you tell customers about it? Invoice terms, or terms of trade, outline the expectations for both your business and your customers for everything related to invoicing and payment. It’s an ideal place to detail your late fee policy, and having it in writing makes it easy to refer your customers in the event you enforce a late fee.

You can also give customers warning when they’re getting close to the invoice due date. For example, you may send a reminder email the day an invoice is due, and mention that if they don’t pay the invoice when due, a late fee will apply.

Steps to take if clients continue not to pay

While charging interest on overdue payments will encourage customers to pay their invoice quickly, it won’t always work. So what do you do then?

There are four steps to effectively chase overdue invoices from clients. 

1. Don’t give up on it. Keep contacting the customer, reminding them the invoice is overdue for payment. Showing them you’re not going to let it slide will provide more impetus for them to pay you.
2. Send a legal letter. Have a lawyer send a formal letter that details how much the customer owes, including any late charges, the deadline for them to respond (usually between 7 and 28 days) and the action you’ll take if they still don’t pay.
   
3. Engage Debt Collectors. This can often be the signal to your client that they need to pay.  This allows you to have someone engage your late paying customer and do the time-consuming followup for you. It will cost 20-30% of the invoice unless you have specified this prior in your terms of trade.
4. Take legal action. There are a range of avenues available to recover invoice payments, and it generally depends on the value that’s outstanding.

• • The Disputes Tribunal is for $30,000 or less;
  • The District Court is for $350,000 or less;
  • The High Court is for invoices above $350,000.

Taking legal action is expensive and time consuming, and not something to be taken lightly. It’ll also likely terminate your working relationship with your customer.

• Enforce the judgment. If the court finds in your favour, that still isn’t always enough to get your customers to pay what they owe. If that happens, you can write to the court to take further action and it can enforce the order.

Conclusion: Avoid overdue invoices through FundTap

Late fees are an effective tool to promote cash flow in your business, but they’re not a silver bullet. Even when you charge interest on overdue invoices, some customers will still not pay on time. 

The money you make from late fees is fairly insignificant, especially when you’ll be under pressure from the limited cash flow that results from an unpaid invoice. This is where FundTap can help.

FundTap is an invoice financing service that takes away that cash flow pressure when customers don’t pay invoices on time (or even when they do, but you need money for something). 

It works by lending you the value of your invoices before they’re paid. When customers pay the invoice, you repay FundTap, plus a small fee. The advantage of using FundTap is being able to cover overheads and investment opportunities that are due in the time it takes for customers to pay invoices.

Using FundTap doesn’t mean you won’t have to chase late invoice payments, but it will deal with your biggest problem when it happens – having the cash when needed to keep operating your business as you recover overdue invoices.

FundTap is quick, easy and affordable, and designed specifically to meet the needs of small to medium sized business owners. 

Find out more about how FundTap works, or try a free demo today.