13th March, 2020
Long waits on invoice payments cause headaches for small business owners. Is a late payment fee the answer? In this article, find out how to weigh up the pros and cons – and implement a late payment system that could help the money keep flowing in.
Small business owners spend vast amounts of time and energy chasing payments that exceed 30 days. Some wonder whether implementing a late fee when clients don’t pay promptly would be worthwhile.
It’s a fair consideration. A report by the Australian Small Business and Family Enterprise Ombudsman estimates that 90 percent of small businesses are failing due to cash flow problems, with one report revealing that 57 percent of businesses are using credit cards to try and offset late payments.
The same report also reveals that the vast majority of time-poor business owners spend less than five hours a week chasing down payments they’re owed.
The ASBFEO, Kate Carnell has said small and medium-sized businesses are commonly waiting an average of 56 days to be paid, which is an untenable situation for many.
And a recent survey of 1200 SME owners across the country found that businesses with a revenue of between $10 million and $20 million in revenue wait an average of 40 days to get paid.
Meanwhile, smaller businesses with revenues between $1 million and $10 million are waiting an average of 66 days to be paid.
READ: Basics of small business invoicing for beginners
At any given time, SMEs have a third of their revenue tied up in outstanding invoices. The end result is the stunting of Australian small businesses growth.
Regulators and industry watchdogs are investigating a legislative approach that requires big businesses to be more transparent about their payment terms.
Carnell also pointed out Telstra and Rio Tinto have voluntarily moved to 20-day payment terms for small business suppliers in recent weeks after mounting pressure.
“The bottom line is that all businesses should be paid within 30 days,” said Carnell.
The waiting game to get paid raises questions about whether small businesses should consider adding a late fee to their invoices.
Designed to incentivise clients to pay quicker, a late fee can vary between five percent and 20 percent – although there are mixed thoughts on whether it’s a good idea.
In Australia, a business owner can charge a late payment fee if it’s reasonable (so long as it’s not disproportionate to the terms of the agreement or unduly onerous).
It’s also critical that the terms of the late payment fee are clearly explained in the contract documenting the business agreement. The best way to do this is to add it as a payment clause in the contract’s terms and conditions.
Successful implementation of a late payment fee in your business is about three things:
Be extremely clear from the start of the business contract that you charge late payment fees. Document the amount that a late payment fee will cost and the date from which it will accrue both on the original agreement (contract) with the client and on the invoice you send them when it’s due.
Be proportionate about the amount charged for a late payment. While there are no hard and fast rules about how much to charge for a late payment fee, make sure it’s an amount that will encourage the client to pay on time and that will cover at least the admin time to chase up the payment.
Contact the client when the invoice becomes due and gently remind them that you’re owed payment. Hopefully they’ll take the hint and pay without delay.
If they still haven’t paid, be prompt and clear in sending them a new invoice including the late payment amount. Keeping communication channels open and respectful is key to maintaining a good ongoing relationship.
READ: Get paid faster with invoice reminders
Fiona Hamann is the director of a communications firm north-west of Sydney, Hamann Communication, with clients of all shapes and sizes, including small businesses.
She adds a five percent late fee to her invoices, which accounts for the cost of her time to chase clients with follow-up invoices.
Hamann sends a reminder invoice one day after an invoice falls overdue, following up a couple of days later. After a week, she reminds them that a late fee will apply. Generally, the client response and lets her know when payment can be expected.
READ: 5 methods to improve cash flow
Hamann sends up to 10 invoices per month, and in six years, she’s only charged one client a late fee.
“I want the fees to be enough of a deterrent for clients to think twice about making late payments, but not enough that I’m seen to be profiteering from them. I also want them to reflect a fair figure based on costs for my time to pursue the late invoice,” said Hamann.
She points out that late fees and debt collection costs need to be approved by clients in the initial contract and can’t just be tacked on without notice, so she lays it all out in her client contract.
“I’ve found that since I’ve included late fees in my contract up front, and they need to agree to it, clients are more aware, and also more communicative about late payments,” she said.
“Ultimately, I want to maintain a good client relationship and ensure I get my agreed invoice amount, and I’m not interested in the late fee. I have it there as a deterrent, and it works.”
READ: How to make payment by invoice quick and easy: 7 best practices
Christian Borkowski is the director of financial advisory firm, PrimeAdvisory.
While implementing late fees is often discussed with clients, it’s rare among small businesses because of the risk to valued client relationships. It’s also more difficult for smaller businesses with limited resources to enforce, he adds.
It’s important to consider implementing late fees carefully. He points out that if someone isn’t paying what’s owed, and then you increase it, it can make being paid even less likely.
“Over the years, I’ve seen that there’s a significant risk of damaging client relationships if you do charge interest or late fees on late payments,” said Borkowski.
Consider what’s industry norm when it comes to deciding whether to charge late fees or not.
“My view is that a small discount for on-time payments is less expensive in the long-run. You can adjust your pricing slightly to mitigate any expense related to the discount and maintain your profitability.
“It’s a more positive way of incentivising on-time payment,” he said.
Alternatively, you could charge upfront to avoid the need for late payment fees if it’s common in your industry and likely to be acceptable to your clients, Borkowski adds.
Davie Mach is the director of Sydney accounting firm, Box Advisory Services. In his experience, late fees are typically more common among small businesses with recurring business models, such as subscriptions or monthly billing.
“In cases where a late fee is enforced, having appropriate communication channels to discuss this and the discretion to waive or adjust based on the outcome is important.”
He adds that prevention is better than cure.
“Make every effort to have your clients and customers pay on time.
“And in cases where a late fee is enforced, having appropriate communication channels to discuss this and the discretion to waive-adjust based on the outcome is important,” said Mach.
Despite gentle reminders and clear and respectful communication, sometimes a client still won’t pay.
Business Australia suggests the following course of action:
Double-check your contract and make sure you understand the terms of your contract for the payment conditions and debt recovery options.
Send your client a letter of demand, or ask your lawyer to draft one for you. Be aware that you have legal and consumer law obligations when contacting other businesses about debt.
If other methods haven’t worked, you may need to consider dispute resolution or engaging the services of a debt collection agency.
4. Take legal action
Failing all else, depending on the size of the debt, you might consider taking legal action.
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