Like Ernie is discussing with Bert, including interest on past due accounts is not always an easy idea to implement.
As a case in point, not too long ago our office received a claim for $85,000 for the sale of electrical supply products. In reviewing the statement of charges, each invoice was assessed interest compounded at 2.0% per month.
However, while attempting to verify the interest calculation, we were also looking to confirm if the assessment of interest had been originally included and agreed upon within the contractual documentation. Since it appeared that these items had not been clearly defined and agreed upon up front, the actual claim value to be pursued came into question.
Since the assessment of interest on past due invoices can be very beneficial, allow me to share a few important points for your consideration.
1) In almost all cases, you can only assess interest when this is clearly written into your customer application, contract, purchase order, etc. prior to commencing with the transaction. As an example, including the clause, “Accounts not paid within terms are subject to a ___% monthly late fee.” in your contractual documentation will at least give you the minimum legal right to assess interest on past due accounts. Conversely, including this interest clause for the first time on your invoice after the product has already been shipped would make it legally questionable.
2) Although I offered the example phrase, “Accounts not paid within terms are subject to a ___% monthly late fee.” please bear in mind that an interest assessment clause should be crafted in line with the nature of your transactions. I believe a rule of thumb is that as the value and complexity of the transaction increases, the terms and conditions related to the assessment of interest may also need to be more carefully crafted. This is something where your legal counsel should be requested to either review or craft directly.
3) Broadly speaking, most applications include an interest rate being charged between 1.0 – 1.5% per month in the US. Some states restrict the amount of interest but you’re most likely safe if it’s capped at a rate of less than 18% per year. There are a couple of reasons for keeping a cap on interest rates.
- Rates that become excessive can be construed as usury and this could possibly result in a violation of local and/or federal usury laws.
- Charging a high interest rate can give an uncomfortable impression to the customer and possibly the business community.
4) Select billing software with built-in templates for charging interest. Although the software may have several interest rate calculation options, I would like to suggest that you randomly test the calculation performed on several invoices so that you have confidence it’s being calculated correctly.
5) From a collection perspective, assessment of interest provides three important benefits:
- It can often act as an incentive to a customer to avoid being late.
- In the event of a dispute, having interest as part of the total claim value allows more room to negotiate a discount or settlement.
- Should the account be submitted for collection, being able to pursue both principle and interest helps to defray collection, and if necessary, suit costs.
Of course not assessing interest is also an option. Depending on the customer relationship, credit worthiness, current and future sales, the competition, and other factors, not including interest is a very important part of the credit and sales decision-making process.
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This article has been edited by Steven Gan.