If you have been in business for any length of time, you have likely heard, “the check is in the mail,” and a myriad of other phrases designed to appease you in hopes that you will stop asking them for payment on their open invoices. Unfortunately, in many cases, that check never comes; or, it comes after many more tiring attempts to collect it, stopping short of going to the customer, taking their hand, and writing the check for them. Late fees and finance charges seem like they may be an effective way of avoiding late payments; but, I encourage you to read on for five things you should consider before deciding to implement this strategy in your business.
Before I dive into the considerations, I would like to take a moment to clarify that there is a difference between late charges and finance charges. Late charges are amounts added to a customer’s bill for late payment where credit arrangements were not made. Finance charges are amounts added to a customer’s bill for late payment where credit arrangements were made (a credit application was completed and verified and terms of the credit arrangement are spelled out in great detail in one signed document). For the purposes of this post, we are only going to focus on late charges.
#1 – Compliance
In my state, there are state statutes that govern late charges. Before you consider adding late fees to your customers’ invoices, be sure you know what your state’s statutes require of you in order to do so. Failure to follow these procedures will make it nearly or completely impossible for you to collect these fees should you ever have to pursue legal means to collect. For instance, in order to charge late fees in Wisconsin, a merchant is required to:
- Give notice or have a signed agreement at the time a contractual relationship is established (not after they have failed to pay on time) detailing when the payment is due and what the penalty or late payment charge will be if payment is late. Since the burden will be on you to prove that you did provide notice, a signed agreement is probably the best route here.
- Once a payment is late, the merchant must NOT allow the customer to add more charges to the already past due account. This represents a challenge for most small businesses because often times the sales representative is not aware that a customer is past due on their account, especially if nobody is really tracking or watching this very closely.
- The maximum late fee that can be charged is 1% per month or 12% per year.
If you aren’t already following these requirements, the time and energy that you need to put into implementing these practices in your business may or may not be worth the reward.
#2 – Timing
If you remember from earlier, when you plan on adding late fees to a customer’s bill, you need to give the customer notice of this before their payment is late and detail in that notice when payment is due and what the penalty or late payment charge will be if they are late with their payment. This requires someone to be monitoring your open invoices regularly and consistently to ensure that late fees are applied in a timely fashion with consistency. Failure to do so sends the message to your customer that your billing is disorganized or that they can continue to pay late because sometimes they will incur late fees but sometimes they won’t.
#3 – Bookkeeping
I have been doing bookkeeping for over almost 20 years now and I can say with great certainty that late fees are almost NEVER paid by customers. This means that someone either needs to spend time and money chasing down what are usually menial amounts; or, they must write these amounts off. In either case, the fees clearly fail to accomplish their intended purpose, which is to encourage earlier payment.
#4 – Return on Investment
If you haven’t already figured it out, considerations one through three all require time and money. Unless you are dealing with some pretty significant past due amounts, the amount of late fees collected may not exceed the costs of implementing them, and that’s if the late fees are actually collected.
#5 – Customer Relationship
In my humble opinion, this is probably the most important consideration. Using negative reinforcement rarely adds to the glamour of a relationship. Adding late fees to your customer’s invoice will likely do more to create ill-will than it will to encourage faster payment. Of course, you must always consider whether or not you want to keep a customer who doesn’t pay on time; but, in many instances, they do eventually pay, they are just slow in doing so. Those types of customers are still contributing to your bottom line; so, it would be nice to keep them if you can.
So how do we get those slow paying customers to pay in a more timely fashion? Here are a few suggestions that I have implemented over the years with great success.
- Mark up your proposals (or increase your prices) ever so slightly to accommodate offering an early pay discount like 2/10 Net 30. This means that a customer can take a 2% discount if they pay within 10 days, otherwise they pay full price if they pay beyond that (this tactic is using positive reinforcement to get the results you want while preserving the customer relationship).
- Require payment up front (for services especially) along with a fixed price agreement or proposal confirming the understanding between both parties of what is to be delivered in order for the agreement to be fulfilled and what recourse the customer has if the agreement is not fulfilled to their satisfaction.
- Have an established procedure for staying on top of past due invoices and follow up on them often and consistently. Trust me when I say, accounts payable people do not like to be pestered by people looking for payment; so, if there is a vendor in particular who is consistently nagging them, that vendor will pretty quickly be moved to the top of the priority list for payment so they can make that pest go away.
You can learn more about keeping your cash flowing in a healthy way from our previous post, 4 Tips You Can Use in the Service Industry to Collect Customer Payments Faster.
Sources: State of Wisconsin Department of Financial Institutions, “Open Accounts: Late Charge or Finance Charge”, https://www.wdfi.org/wca/business_guidance/creditors/late_charge_vs_finance_charge.htm