Key point covered in this lesson:
• Incentivising proactive payment
• Is it legal to charge late fees on overdue payment
• Penalty vs. interest
• How much is too much?
Although paying on time is not exactly something that should be celebrated, there are those customers that you know will often make you wait longer than the stipulated payment due date. While you are effectively financing the transaction by offering 30-day or more payment options, you are incurring cost on that.
One possible solution would be to offer some sort of incentive for early settlement. This could come in many forms like a fixed reduction amount, percentage saving, or some other form of benefit or compensation the customer might perceive as preferential. With customers that are known to default on your payment terms, you could take this incentive into consideration when quoting initially.
(This is a bit of a legal minefield so please check that I have the facts straight)
It is legal in New Zealand to charge fees on late payments. There are however certain criteria that have to be met for you to legally be able to enforce such fees. The below is a very general explanation and criteria differ greatly between different industries and types of businesses.
For advice tailored to your business we advise that you meet with one of our account managers who would be able to deliver advice specific to your business.
Firstly, the late payment fees need to be considered “reasonable”. Although what is reasonable in one instance might be quite unreasonable in another.
According to the Credit Contract and Consumer Finance Act (CCCFA):
The maximum rate of charge that is recoverable under a high-cost consumer credit contract is 0.8% per day, calculated in accordance with the regulations as a proportion of the amount of credit provided.
However, the late payment fees you plan to implement also need to be stipulated in a signed agreement between yourself and the customer.
The two most common forms of late payment fees are Penalty, and interest.
Penalties can come in a range of types but generally speaking it’s a once off amount or once off percentage that is added to the outstanding amount.
Penalties are simpler to calculate and easier to understand for yourself and the customer. It is also far less work and is therefore most commonly used with smaller amounts due.
Interest can be calculated in a few different ways and the way it is calculated would be determined by whether it is added daily, weekly, monthly or annually. It could also be either compound, which means interest is charged on the outstanding amount as well as accrued interest, or just on the outstanding amount.
Safe to say, chances are the customer might be uncertain what the exact amount due will be by the time he is ready to settle his account. Interest also takes quite a bit more time to calculate and time is usually the most scarce resource at any business.
Not more than what can be considered reasonable, but no less than what is required to convince the customer to pay. It is important to remember that fees on late payment serves the purpose of supplementing loss due to a lack of cash flow, and to convince the customer to pay to avoid further cost escalation. The purpose of late payment fees is not to incur additional profit.