Dealing with clients who won't pay up is a common complaint among freelancers. Late fees are one good way to discourage this kind of behavior, but they aren't appropriate in every situation. You'll need to review the terms of your agreement with your client and the laws of your state to determine when and how much you can charge. In some cases, you might find that finance charges are causing you to lose clients and your business would benefit from forgiving the occasional late payment.
A late fee, also known as a finance or service charge, is an amount of money a company assesses on a past due invoice. You can also think of a late fee as a charge for extending credit to a late-paying customer, as the company is allowing the individual more time to pay for a debt they currently owed. Calculated properly, late fees compensate the creditor (you) for the direct losses you suffer when the debtor doesn't pay on time: lost interest (assuming you'd place the money in an interest-bearing account); and the cost of calculating the fee, sending the notice, and pursuing payment. The mere presence of a late fee provision often encourages clients to pay invoices on time.
If you decide to impose late fees, you must determine when and how much to charge. Consider your own cash flow needs and standards of your industry when setting deadlines and fees (never treat late fees as an additional way to make money—they are not a profit center). As for timing, your policy could be that invoices are due on receipt and will incur late charges if paid later than 30, 60, 120 days, or longer.
Next, you should consider how much you want to charge in late fees. You might set late fees as a percentage of the invoice amount, calculated on an annual basis (more on that calculation below). Alternatively, you might charge a flat late fee, such as $10 for each day overdue, with a cap. In either case, late fees cannot be more than an estimate of the actual costs you incurred due to the client's late payment, and your state's statutes might restrict how much you can charge per year.
If you charge no more than 10% per year, you probably won't run afoul of your state's statutes, but your client could challenge the fee amount in court if you charge more than a reasonable estimate of your actual losses. To calculate your potential losses, consider the following:
Be careful applying an interest rate to large invoices, as the fee could end up much higher than your actual expenses. If you charge a flat fee, verify that the charges do not go over the state's limits for small invoices. For example, if the invoice is for $100, and you charge $10/day for overdue invoices, you would be over the legal limit of 10% per year after one day.
You should assess a late charge only if the client was on notice, at the outset, that you reserved the right to do so. If you have a written agreement with the client, it should specify how long they have to pay and the flat fee or monthly finance charge for paying late. You should include the same language on your invoices by including the phrase "accounts not paid within __ days of the date of the invoice are subject to a __% monthly finance charge." Never, never describe the fee as a “penalty” for late payment; it's a tip-off to a judge that the amount you're charging is meant to punish the debtor, not compensate you for your losses, which can result in the court refusing to enforce your provision. If your written agreement and invoice did not include provisions regarding late fees, you likely cannot impose finance charges.
A late fee is normally assessed as a monthly finance charge, which you can calculate by completing two steps. First, divide the annual interest rate set in your agreement as a late fee by 12 to determine your monthly interest rate. Next, multiply this monthly rate by the amount due to determine the amount of the monthly late fee.
For example, if the annual interest rate is 3%, the monthly interest rate is 0.25%. If a client owed you $10,000, you'd multiply this amount by 0.25% to figure out how much the client owes you every month as a late charge. One-quarter of a percent of $10,000 is $25, so the client would owe you an extra $25 for every month their payment was late. In this example, the annual interest rate caps the fine at 3% of the original debt (not compounded). You would charge $25 per month even though the debt increases. Refer back to your agreement to determine if and when to compound interest, again verifying that the annual amount does not exceed the legal limits.
Late fees can result in unnecessary stress and tension with your customers. In some cases, the better option is to ask for payment before completing services. When advance payment is not practical, consider whether late fees are truly necessary, or whether they are causing you to lose customers. When you forgive the occasional late payment, you could make more money in the long run by maintaining positive relationships with your clients.
Instead of punishing customers for paying late, you could instead reward early payments by offering a discount for payments made up front or within a specified time, so long as you do not offer discounts as a way to get around the restrictions on late fees. The incentive might reduce the number of late payments, and you will enjoy the added benefit of speeding up cash flow to your business. It is important to verify that the difference between the discount and the invoiced amount does not exceed the law's limits on late fees. If the discount is large, a judge might find that it is a disguised illegal late fee and rule that your agreement is unenforceable.
In some cases, a client just won't pay but you need the money to keep your business going. First, resend the invoice and reach out to your client to find out what the holdup is. The client might have an issue you can easily resolve, such as forgetting to submit payment or running into an issue with your online payment system.
If the client still won't pay, it might be time to take legal action. If the amount is small, you can file a claim in small claims court, which you can read more about here. For larger disputes, consider reaching out to an attorney for legal advice.