Whether you’re a small business owner or part of a megacorporation, getting stuck with an invoice late fee on top of the total amount due is never fun. And while having to collect invoices (and enforce invoice late fees) can be expensive, time consuming, and frustrating for suppliers, finding ways to avoid those fees while maintaining positive cash flow can be just as challenging for buyers.
Fortunately, by understanding how late fees work and following a few basic best practices, you can minimize or even eliminate overdue invoices and late payment fees from your accounting workflows and manage your working capital more effectively.
What are Invoice Late Fees?
Getting paid on time is something every business strives for. But when customers don’t pay their outstanding invoices in the timeframe dictated by the terms and conditions of the purchase agreement, companies use invoice late fees as a combination penalty, compensation, and incentive.
More properly, the penalty itself is meant to serve both as compensation for the seller’s inconvenience and an incentive for the buyer to make prompt payments. Generally speaking, the late fee can be considered to be roughly equivalent to the interest lost on the outstanding amount (provided the seller planned to place the money in an interest-bearing account), with the additional costs of calculating and obtaining the fee itself.
How are Invoice Fees Calculated? Can Suppliers Charge Interest?
Laws vary by region, but generally suppliers have some legal right to charge late fees as determined by the jurisdiction in which they operate. In the UK, for example, the Late Payment of Commercial Debts 1988 Act classifies late fees as “statutory interest” and caps it at 8% plus the base rate currently used by the Bank of England (BoE) for business to business (B2B) transactions. (This interest rate is not claimable if the parties have agreed to a different rate of interest in the purchasing contract or are providing goods and services to a public entity).
So, for example, if Supplier X issued an invoice for £2,000 and the BoE base rate was .4%, the annual statutory interest rate would be £170 (£2,000 x .085 = £170).
To obtain the daily rate, we divide this amount by 365, which comes to 47p each day (170 ÷ 365 = .47).
Finally, we apply the daily rate to determine how much actual interest is owed on the invoice. If the invoice is 30 days past the due date, the accumulated interest, and therefore the late fee, would be £14.10 (30 x £0.47 = £14.10).
Another option suppliers use when issuing invoice late fees is a flat fee. In this example, Supplier X has a policy of charging $20 for every month unpaid invoices under $500 are overdue. So an outstanding invoice for $250 that’s 60 days overdue will now include an extra charge for $40 (two months of fees), bringing the outstanding total to $290.
In other parts of the world (for example, the United States), the right to charge paying customers late fees, or charging interest that is functionally equivalent to a late fee, is generally acknowledged but has different limitations from state to state and industry to industry. In such cases, it’s important to seek legal advice to ensure your purchasing activities conform to both industry and government standards and both you and the supplier are adequately protected from bad actors looking to exploit loopholes (or simply rip you off).
Generally speaking, suppliers, whether they’re small businesses, corporate entities, or freelancers, will be willing to negotiate in good faith, provided the customer in question doesn’t have a well-established history of unpaid invoices trailing behind them. Some might agree to lower interest rates, converting interest to a flat fee, or allow especially valued clients to bundle overdue payments into one lump sum to consolidate and reduce the fees.
If it’s an isolated incident and sufficient value is placed on the relationship with the client (or as a gesture of good faith for a new client), some suppliers may end up waiving the late fee altogether, although that’s not something most buyers can or should expect when planning their spend.
“In addition to the extra expense that comes with unpaid invoices and their late fees, buyers can suffer other consequences with more serious long-term impact. Damaged supplier relationships can lead to suppliers raising interest rates or demanding payment on receipt, for example, tightening cash flow management even further.”
The Consequences of Late Invoice Payments
Timely payments are of course the goal of most buyers. Late payment charges and other additional charges (as dictated by the purchasing agreement) can quickly siphon up cash intended for paying other bills, investing and innovation, or covering emergencies. A sudden tightening of cash flow can create a chain reaction, making it harder to pay other bills on time and triggering a cascade of overdue invoices and additional late fees.
In addition to the extra expense that comes with unpaid invoices and their late fees, buyers can suffer other consequences with more serious long-term impact. Damaged supplier relationships can lead to suppliers raising interest rates or demanding payment on receipt, for example, tightening cash flow management even further.
In more extreme cases, unpaid invoices can result in having the debt transferred to a collection agency (damaging the buyer’s credit) or even lead to a visit to small claims court.
Best Practices for Avoiding Invoice Late Fees
Even modest late fees on top of the actual invoiced amount can be a thorn in your financial side. Add in monthly finance charges, the stress of dealing with endless payment reminders, and the spectre of a collection agency lingering just out of sight, and finding ways to avoid invoice late fees altogether quickly becomes the most attractive option.
You can protect your reputation, credit rating, and cash flow by following a few simple best practices for paying what you owe.
1. Invest in Digital Tools
It’s hard to pay on time, let alone achieve optimal cash flow, when you don’t have a clear picture of your spend. Choosing a best-in-class, end-to-end procure-to-pay solution like Planergy can help in several important ways:
- Centralized, comprehensive, and cloud-based data storage, access, and analysis.
- Integration of your software environment for clean, clear, and complete data from diverse sources.
- Artificial intelligence, process automation, and integration with supplier systems via electronic invoicing (eInvoicing) and punch-out catalogs eliminates human error, boosts speed, accuracy, and efficiency, and helps shorten processing cycles so invoices can be paid on time or even early to capture supplier incentives.
- Closed systems to eliminate rogue spend and invoice fraud that can hamper financial reporting and planning.
- Powerful analytics and real-time reporting to simplify cash flow management.
- Integration of supplier management, contract management, inventory, and other modules with your accounting software to ensure all purchases adhere to negotiated terms and conditions for price, due dates, quality, quantities, etc.
2. Understand Your Cash Flow Needs
Every business has its own working capital needs and goals. Cash flow planning that works for a traditional brick-and-mortar retailer with steady year ’round income would quickly sink a seasonal business that does 90% of its sales in just three months.
Reviewing historical and current spend activity can not only provide you with your current cash flow management needs, but help you anticipate and plan for the months, quarters, and even years ahead. Leveraging your spend data in this way can help you make more prompt payments, and also take advantage of early payment discounts from vendors who offer them.
A seasonal business, for example, can create financial reports they can use to negotiate a payment plan with their suppliers where they pay the bulk of their outstanding invoices upfront in their busy months (when they’re flush with cash), and then a smaller set amount each month to round out the balance over the “lean” months when cash flowing in isn’t nearly as great.
You’ll have a much easier time converting all that data into actionable insights if you’ve invested in a purpose-built software solution, since it gives you power, speed, and accuracy traditional pen-and-paper, manual workflows just can’t match.
3. Take A Collaborative Approach to Supplier Relationships
Finding suppliers who don’t just meet your needs for goods and services but share your desire for mutually beneficial relationships can go a long way toward helping you avoid overdue invoices and late payment charges.
Based on your own cash flow management needs, try negotiating flexible terms (including options such as payment plans for large invoices, splitting payment between upfront and back-end amounts, sliding scales for early payment discounts, etc.). Having the option to take advantage of early payment discounts, split payments, or even delay payment now and then without additional charges can be a win-win arrangement for both parties, since they’ll have a long-term client and you’ll have flexibility you need to get them their money while still preserving sufficient working capital to protect your own business continuity.
Vendors who accept multiple forms of payment can also prove invaluable. Being able to pay with a credit card with a promotional 0% annual interest rate and zero monthly finance charges, for example, ensures the supplier gets paid on time without damaging your credit rating, reputation, or cash flow. (Provided you’ve properly managed your available cash to cover the credit card bill before the end of the promotion, that is—another area where having a centralized software solution can help).
It pays to prioritize relationships with vendors who are also investing in digital transformation planning, too. When both parties are fully paperless, automated, and have integrated their systems, processing times are lower, payments are made more quickly and accurately, and everyone has the information they need to work toward mutually satisfactory outcomes.
And, of course, making it clear you’re as eager to pay them as they are to get paid will help you find a middle ground that strengthens your supplier relationships and keeps your cash where it belongs.
4. Get It in Writing
This might seem like a given, but clear and comprehensive payment terms should be spelled out as explicitly as possible for every vendor in your supply chain. The agreement between your organization and each supplier should include detailed information on:
- Credit policy.
- Payment terms.
- Accepted payment methods and related policies.
- Late payment policy.
- Early payment discounts.
- Delayed payment promotions with no penalties.
- Payment plans or split payment options.
Getting everything down in writing helps minimize confusion and miscommunication. It also provides a formal, legally binding agreement both parties can refer to with confidence when resolving disputes.
Invoice Late Fees Don’t Have to Be Part of Your AP Process
They might seem as inevitable as death or taxes, but invoice late fees don’t necessarily have to darken your financial doorstep. By taking a proactive approach to cash flow management, investing in digital tools you need to see, manage, analyze, and plan your spend, and making communication and collaboration part of your supplier management plan, you can make sure you’re paying your bills strategically—and saving your cash for growth instead of late fees.
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