What is Arrears Billing and How Does It Work

What is Arrears Billing and How Does it Work?

Most businesses typically bill customers in two ways – advanced billing and arrears billing. In this article, we’re going to talk about the latter. When it comes to billing your customers, getting to know how to bill in arrears versus billing in advance is helpful before setting up your actual billing process. In the following sections, we will discuss what it means to be paid in arrears and other available options.

What Does Arrears Billing Mean?

As mentioned earlier, the two most common options for billing are: billing in advance and billing in arrears. The latter means you will bill your customers after the job is complete. So, instead of paying beforehand to cover expenses or other potential costs, you elect to wait until the completion of work is paid. This billing process is also referred to as “paid in arrears” or “invoice in arrears.”

Here’s an example: let’s say you’re an electrician doing a small, one-time electrical job for a homeowner. When you finish your work, your client will pay you at the end of your visit. This simple process is arrears billing. If you’re a freelance web developer, you may get paid after sending an invoice in arrears. That means you will bill your client after finishing the work and not before or during the project.

For small business owners, arrears billing is the simplest way to manage your billing process. However, it can be challenging to maintain proper cash flow. However, you do have other billing options, so make sure you utilize them properly.

When to Use Arrears Billing?

Arrears billing is essential for businesses that are paying their employees an hourly rate. It’s also useful for companies that bill in periods or cycles, restaurants that need to add tips to paychecks, and businesses that offer sales commissions.

The paycheck or final bill can’t be determined in all of these examples until the designated period is complete. Most of the time, businesses are unsure about the number of hours their employees will work. It also doesn’t make sense to pay a period in advance when the final number of hours could change before payday. Since it’s much easier to pay after a period or after the service has been rendered by an employee, the pay they get is considered as “payment in arrears.”

Arrears Billing Example

Let’s say you run a small business that features a workforce of over 40 employees – all on hourly wages. You project 20 hours for each of them. If you’re not using arrears, you would be paying a total of 800 hours in advance. If you encounter an issue and have to close for two days, you’ll have to either adjust all of those paychecks or take them out for a future paycheck. Either way, it would be a complete mess for everyone involved.

For this matter, it’s also common practice to hire other service-based businesses to help you with your billing. In most cases, customers are hesitant to pay large bills for advanced services. That’s why businesses charge a percent upfront to request a down payment. Then, after the service is finished and both parties are satisfied, the customer will pay the remainder of the balance. Since the customer is paying after the completion of service, this process is also considered arrears.

Any payment made after the completion of service is considered arrears billing. So, if you think that this type of billing works for you and your business, make sure you take full advantage by incorporating it into your billing process.

Industries that Use Arrears Billing

Arrears billing is a common billing method among a variety of industries and financial situations. Some notable examples are the following:

  • Companies that pay an hourly rate.
  • Restaurants that need to add tips to their regular wages.
  • Independent contractors.
  • Businesses that pay for sales commissions.
  • Loans and annuities that a business pays per month.
  • When preferred stockholders of a company are owed dividends.
  • Utilities like water or electricity.

Essentially, any business that collects charges and bills on rolling basis benefits from arrears billing. So, if your business falls under these industries, it will thrive greatly when you utilize arrears billing.

Difference Between Arrears Billing vs. Billing in Advance

The difference between arrears billing and advance billing is pretty straightforward. With arrears billing, you get paid after completing the work. On the other hand, billing in advance involves sending an invoice for the total amount before starting the job.

While this process makes it easier for your business, it can test the trust of your customer. If they’re skeptical about you doing the job and meeting their expectations, they may be unwilling to pay in advance. On the other hand, advance billing is ideal for repeat customers in industries where this type of payment method is standard.

Other Available Billing Options

In addition to billing in arrears and billing in advance, there are other billing options available. These are the following:

  • Scheduled payments: are you managing long-term projects? If so, ReliaBills has a scheduled payment calendar feature that will prove handy. It divides the project into multiple, measurable specifications. For instance, an article writer may bill their client a percentage of the full payment after initial drafts are approved. Another portion of its halfway through the article or book that the writer is composing. The rest of the amount will be given once the article or book is finished.
  • Retainers: industries that perform ongoing work regularly will require advance payments or an automatic, upfront payment schedule. Good examples include monthly legal help, accounting fees, or IT services.
  • Initial deposits: this type of billing method involves charging customers for an initial deposit that serves as a percentage of the total amount. For example, gardening companies may charge for the cost of supplies upfront before beginning work on a larger landscaping project.

Pros and Cons of Billing in Arrears

Billing in arrears is an excellent option for many businesses – particularly by the industries mentioned previously. However, it’s not for everyone. While it may have a ton of advantages, it also has some downsides that need acknowledgment.

With all the business decisions you make, there will always be pros and cons when you consider billing in arrears. To help you determine if this billing method is right for you, consider its pros and cons:

Pros

  • Flexible and convenient option for both your business and your customers.
  • Limits the amount of refunds that your company will need to process.
  • Allows your business to get paid in full for all products or services you provide.

Cons

  • Overdue payments, which means lesser cash in your business.
  • Requires time and effort to set up a consistent and automatic arrears billing process for reminding customers to pay.
  • Potential risks that your company might not get paid by your customer after the work is done.

How to Mitigate the Risks of Billing in Arrears

If you’re doubtful about arrears billing due to its potential drawbacks, you can reduce these risks with the following:

  1. First, check your customer’s credit to make sure they have a high probability of paying their bills.
  2. Second, Help manage cash flow in your business by requiring a deposit or arrears payments as noted above.
  3. Third, use tools like ReliaBills to help you track your invoices easily. With the simple click of a button, you can set up, schedule, and track your invoices. You’ll even get real-time notifications via email on the status of your invoices. For more information, visit www.reliabills.com.

Wrapping Up

Billing in arrears is one of the best options that you can use to bill your customers. However, it also has potential drawbacks that might harm your business moving forward. Make sure you do your research and conduct tests to make sure if this billing method is the right one for you.

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