As a small business owner, you need customers to survive. Depending on your business, you might extend credit to customers so they don’t pay right when they receive a good or service. When you invoice a customer, you include payment policy terms that detail when the money is due. If they don’t pay until after the deadline, you are paid in arrears.
You also have a lot of expenses when you are a small business owner, like rent, supplies, and payroll. Vendors might send you invoices instead of requiring immediate payment. From time to time, you might be billed in arrears or make a payment in arrears.
What does in arrears mean?
In arrears means payment is behind. Arrears can mean payment is overdue, or that the payment isn’t due until after the service period. Businesses can make payments in arrears to vendors or receive payments in arrears from customers. Employees can be paid in arrears, meaning they don’t receive wages until after the pay period.
When someone selling a good or service is paid in arrears, they don’t receive money until after the pay period is over. This can be the result of one of the following:
- The vendor did not bill the customer until the end of the service period
- The customer’s payment is overdue
As a business owner, you are both a customer and vendor. You are a vendor to your company’s customers. And, you are a customer when making business purchases from vendors.
Billing in arrears
Vendors who bill in arrears do not send a bill or request payment until after the customer receives a good or service. Unlike overdue payments, billing in arrears is not the customer’s fault. It just means that the vendor does not bill until the end of the service period.
You might be billed in arrears from time to time. Utilities are common services you receive but aren’t billed for until the end of the service period.
For example, you receive an electric bill for your business. The bill covers service from June 3 – July 1, and you are billed on July 3, rather than during the service period. Your payment is then made in arrears, but it is not considered late.
You can also bill customers in arrears. After giving a good or service, you don’t bill the customer until the end of the service period, rather than before or during. You will not charge overdue fees because the payment is not late.
Payroll in arrears
Many businesses run payroll in arrears. You pay employees after they have performed work for your business. Their wages are not scheduled for distribution until after the payroll period. Though you don’t give your employees payment until after the pay period, the wages are not overdue.
For example, an employee works from June 31 – August 11. You pay them on August 18, a week after the pay period ends. That means you pay the employee in arrears.
Some businesses choose to run payroll while the employee is still putting in hours for the pay period. This is called current pay. An employee works from June 31 – August 11. You pay them on August 11. In order for the employee to receive their wages on August 11, you need to run payroll a few days before. You predict that the employee will work their set hours. This can be more confusing, especially if an employee calls off work and does not get paid time off.
For small business owners, running payroll in arrears is more simple than calculating current pay.
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Arrears as a result of overdue payments
There might be times when regular payment is behind because it is overdue. These types of payments might be recurring. When the customer does not send one month’s payment on time, their next payment is made in arrears.
Let’s say you pay a vendor monthly for services. You miss your June payment. When you pay the next month (July), the payment will be in arrears for the June payment. To catch up, you would need to make two payments in July— one for June and one for July.
You might also have customers who pay your business late in arrears. This happens if the customer does not pay you during the time frame you request on the bill.
How do these late payments happen?
There are many reasons you can get behind on payments. Here are some reasons for late payments in arrears:
- The customer did not receive the invoice
- The customer recorded the invoice incorrectly
- The customer did not record accounts payable in the accounting system
- The customer did not have the money to pay
If you have accrual accounting, you will mark received invoices from vendors as accounts payable—money that you owe but have not yet paid.
By mismarking or forgetting to mark accounts payable, you could forget that you owe money. As a result, you fall behind on payments. Each catch-up payment you send after the period it is due is a payment in arrears.
Customers who do not receive an invoice, misrecord an invoice, or do not have the money to pay will not give you immediate payment. When (and if) they do pay you, it is behind.
What could result from paying in arrears?
If you pay in arrears and it is considered late, the vendor could apply the following restrictions:
- Increase in interest rate
- Reduced payment terms
- Reduced credit
Or, the vendor can decide not to do business with you again. To avoid restrictions on your business, make sure your payments are timely. Consider using accounting software to track your expenses and income to prevent paying in arrears.
If customers pay you in arrears, you can likewise apply restrictions. To keep cash flowing into your business, you need to avoid customers making payments in arrears. To encourage timely payments, you can implement clearer invoice payment terms. That way, customers know when you consider their payments overdue. You can charge interest after a certain number of days without payment.
Need a way to prevent paying or getting paid in arrears? Patriot’s online accounting software lets you easily track your expenses and income. That way, you don’t lose track of payment due dates. Plus, you can create invoices so your customers pay you on time. Try it for free today!
This article has been updated from its original publication date of July 13, 2017.
This is not intended as legal advice; for more information, please click here.