Late fees aren’t the answer to your cash flow problem

Every business owner has been burned by a late payment (or even nonpayment) before. You followed up, sent emails, and left voicemails, but your client was still full of excuses and the payment was late. And, while you were still upset with your client, you may’ve thought about adding late payment fees and/or interest to your future payment terms. The idea is that the late fees will provide a final not-so-gentle nudge for your client to pay on time or, worst case, you’ll make a few extra bucks for your headache.

In theory, it sounds great. Either you get paid on time or you make more money. Win-win. But, in reality, late fees and interest rarely fix cash flow problems. They’re just a bandage on top of the real problem and don’t fix the core issues in your Accounts Receiveable process (aka your invoicing and collection process). You’re just kicking the can down the road (by ignoring the true underlying issues) or creating other issues (by pissing clients off with fees). Instead of blindly adding late fees and interest to your payment terms, take a hard look at your entire invoicing process, figure out what’s causing friction, and outright ask clients how you can make paying easier.

Late fees don’t motivate everyone:

Some people (and poorly run accounting/finance departments) are just chronically late, forgetful, or all over the place. It’s not you. It’s them. That’s how they live their lives and it carries over into their businesses. And, your late fees won’t make them pay on time because no one’s late fees make them pay on time. They’ll just eat the fee (or ask you to waive it).

Instead: Pair late fees with something that’ll actually motivate them to pay (for example, you’ll stop working when invoices are overdue) or take payments out of their hands and set up auto-debits.

Covering up other issues :

Late payment isn’t always your clients’ fault. There may be other cash flow issues and friction causing the late payments (for example, sending invoices at the last minute, sending invoices at odd times so they slip thru the cracks, mailing invoices, sending incorrect invoices, sending invoices to the wrong contact, requiring weird payment methods, etc). While adding late fees may cause some clients to prioritize your invoices and deal with the friction, it won’t cause everyoneee to prioritize your invoices. And, as you bring on new clients or scale, the cash flow problem will come back (because it never went anymore to begin with).

Instead: Review your invoicing process for anything that’s making them hard to pay.

Doesn’t remove cash stress :

Late fees might make clients pay on time, but it won’t make them pay quickly. If your payment terms are ‘Due in 30’ and they always pay in 45, they’re not gonna start paying in 3 days. They’re going to pay on the 30th day to avoid the fee. And, you’re still gonna be waiting for the 30th day to see if they paid on time or blew right thru it and decided to eat the penalty.

Instead: If your business needs invoices paid promptly and cash faster, shorten your payments terms or collect upfront.

Souring the relationship:

No one likes late fees or being nickel-and-dimed. Mega-corps do it (and we put up with it) because they’re faceless entities that don’t really care about their customers and there’s like three internet service providers so what’re we gonna do about it 🤷‍♂️. But, client relationships are important in small businesses and, if you’re implementing late fees, you need to make sure you don’t sour your client relationships at the same time. The late fees you’ll collect are negligible compared to losing a client.

If you decide to implement late fees, overcommunicate them and let clients know wayyy ahead of time. Point it out while explaining payment terms in the sales/onboarding process and prominently warn them on invoices. Don’t surprise them with a fee. Surprises don’t get paid on time.

Make sure it’s legal :

Usury is the practice of lending at unreasonably high rates. And, it’s illegal. Talk to your attorney before adding massive penalties or interest to your payment terms. Make sure the amount you’d like to charge is legal and enforceable. You don’t want it blowing up in your face if you take your clients to court or try factoring your receivables (aka selling all your overdue invoices in exchange for 90%ish of the value).

If you decide to implement late fees, run it past your lawyer (and possibly your professional liability insurance, if you expect them to cover legal costs).

(Note: I’m not a lawyer or your lawyer. Usury laws vary widely. What percentage is okay and whether late fees are governed by usury laws depends on your jurisdiction.)

Action Item:

Do a late fees and interest cost-benefit analysis. Is adding legal and reasonable late fees worth the headache?