How to Calculate Finance Charges on Past Due Invoices?

The Invoices Fee That Gets Your Cash Flow Back On Track

Finance charges are an effective, low-effort solution for customers who never seem to pay up on time.

From reminder emails to follow-up calls, getting your invoices paid can feel like a job within itself. And it doesn’t take long for the money chase to suck up your time, resources, and energy. Fortunately, there’s an easy way to eliminate the extra work and headache: Finance charges. In this article, we’ll cover the basics of finance charges, how they encourage timely payments, and what you need to know to start incorporating them into your invoice process today.

Finance Charges, Explained

Otherwise known as a late fee, a finance charge is a cost customers incur once they pass their payment window and grace period. Most invoices will include a payment term that specifies a timeline like Net 30, meaning a customer has 30 calendar days to settle a bill once it is received. So what happens when the deadline comes and goes? Some businesses are left waiting. Others proceed to chase down their money. But the savviest rely on finance charges to claim interest, incentivize faster payment, and build better customer relationships—here’s how they do it.

Adding A Finance Charge To Your Next Invoice

To make finance charges work, you got to be upfront with customers. Start by spelling out your late payment policy and fees in all original contracts; that way, everyone is on the same page, and questions don’t pop up down the line. Then, when it’s time to send off an invoice, include a note about late payments and specify the percentage of interest you plan to charge as a penalty. Here’s are two examples we won’t mind you stealing:

Invoices not paid within terms of ___ days are subject to a flat ___% monthly finance charge.

Invoices not paid within terms of ___ days are subject to a ___% daily finance charge.

If your business utilizes accounting software like Quickbooks and Xero, double-check your current settings to ensure you’ve activated that feature.

How Much Should You Charge?

While there’s no standard dollar amount or percentage for a finance charge, try to resist an excessive figure. The goal is always to collect the original payment and maintain a positive working relationship with your customer. Consider researching what a reasonable penalty looks like in your industry and area, and be mindful of any state laws that put a cap on what you can charge.

Flat Fee Vs. Invoice Percentage

Businesses typically have two choices. Option one: they can set a flat rate for every month an invoice is overdue. For example, let’s pretend your late payment policy is a flat fee **of 1%. To figure out the dollar amount, multiply the outstanding bill by 1% (or 0.01). So if the amount owed is $2,000, the late fee would be $20. What happens if more than one month goes unpaid? Add $20 for every month that passes without payment to the bill total.

The second option allows you to tack on a percentage of your customer’s invoice total—but it requires some extra math. Start by calculating the daily percentage rate. Using the previous figures as an example, we can multiply a fee of 1% by 0.03 to find out 1/30th of 1. The answer is 0.03. Now, let’s assume your customer pays 10 days after their deadline. Multiply the amount due ($2000) by the daily rate (0.03) to get $60. Next, take $60 and multiply it by the total number of overdue days. In this case, after 10 days, you can collect an additional $600.

When To Wave Finance Charges

Sure, overdue invoice finance charges help deter late payments. But there are times when exempting these extra costs is a smarter strategy. Maybe a particular customer needs to know you can work with them. Or perhaps you want to keep a longstanding customer happy. Take time to figure out if the extra fees are worth more to your bottom line or client relationships before taking action.

Don’t Forget To Send Payment Reminders

Issuing notifications about upcoming invoice deadlines is a win-win: Customers avoid overpayment, and you avoid cash flow interruptions. But what about timing? Plan on sending customers a reminder one week before their payment deadline. If they miss their due date, provide a finance charge letter the following day that reiterates your policy. And, of course, start tracking their late fees.