Cash flow is a significant factor which contributes to the financial stability of small business owners. Yet, a third of small businesses are negatively impacted by late payments each year. Whether you have experience dealing with customers delaying payment on overdue invoices, or want to be proactive with your business accounts, consider if charging interest on unpaid invoices is right for your business.

This article will explore the legal considerations for charging interest on unpaid invoices. This involves being proactive in the following ways:

  1. Revisit your business terms and conditions;
  2. Determine and ‘fair and reasonable’ interest rate; and
  3. Communicate well with the customer.

Revisit Your Business Terms and Conditions

Charging interest on unpaid invoices can: 

  • provide a deterrent to late payments; and 
  • help offset ongoing operating costs. 

This is not always a commercial solution depending on the type of business you are operating. However, this approach tends to be more suited to service-based industries.

You should revisit your business terms and conditions to ensure the payment terms are clear, adequate and robustly drafted before your first sale transaction. Well-drafted payment terms make it easier to recover unpaid invoices, whether or not you are also charging additional interest for late payments.

Your business’s terms and conditions should specify the interest rate to be charged on late payments. If not, you will need to refresh your payment terms to hold new customers accountable. Once your business terms are suitable, you can provide your existing customers with the revised terms at their next transaction.

Determine a ‘Fair and Reasonable’ Interest Rate

As a business owner, you should prioritise building and maintaining a large customer base. Accordingly, any interest rate you wish to charge should not be so unreasonable that it deters existing or potential customers. Setting a fair interest rate will avoid a court deeming the rate unfairly high or the payment term unreasonable in the event a customer chooses to dispute the invoice.

Calculating the Interest Payable

There are numerous tools which can assist you in calculating an appropriate interest payable, including:

  • excel spreadsheet; or
  • online Interest Calculator tools.

The basic premise for the ‘per annum’ interest rate is that the percentage rate stipulated should be a portion of the total invoice, payable as interest over a year. For example, you have set an interest rate of 10% per annum on a late payment of $1000. The customer should pay an additional $100 in interest over the year. This is assuming they have not made further payments during the year.

You can calculate the total interest payable by dividing the unpaid invoice total by 365 (being the number of days in a year), then multiply this amount by the number of days the payment is overdue. Multiply this figure by the per cent of interest you are charging.

Communicate Well With the Customer

Suppose you have done the above preparation and remain committed to charging interest on late payments. In that case, you should ensure your payment policy is communicated clearly with your customers. 

Disputes arise more frequently when customers feel they have not been fully informed. To minimise these situations occurring, be sure to specify your payment terms and any interest charges for late payments. It is also best practice to set out the due date on your invoices, particularly when you want to impose a financial penalty on the customer for missing the payment due date.

Be sure to demonstrate how your business focuses on transparency and disclosure with your customers. This will generally be more favourably viewed by a state tribunal or fair trading body, in the event a customer decides to escalate a complaint.

Consider Faster Payment Terms Policy

In New South Wales, business owners who supply goods or services to a participating agency within the state government body can register to benefit from the Faster Payment Terms Policy. From 1 December 2018, business owners who register have the benefit of knowing at least 80% of the invoiced total, to the maximum value of $1 million, will be paid within five business days of receipt by the relevant finance department. Late payments can still accrue interest depending on your specific supplier terms with the government agency.

Key Takeaways

As an owner of a small business or start-up, unpaid invoices can be an administrative burden which challenges your ability to meet the business cost of operation. Many business owners incentivise customers not to miss payment due dates by charging a reasonable rate of interest for late payment. If you have decided this is the right approach for your business, seek legal advice to ensure your business terms are suitably drafted. 

If you want assistance recovering a debt, get in touch with LegalVision’s debt recovery lawyers on 1300 544 755.

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