Late Fees as a Collection Strategy

Credit professionals have reported an increase in payment delays as customers feel the pressure of inflation, supply chain issues and overarching economic volatility. Late payments are more costly than usual in today’s environment as the federal funds interest rate sits at a 15-year high of 4.25%-4.50%—with the expectation to reach 5.66% by the time the Federal Reserve is finished with its rate hikes. Now is the time for credit professionals to remind customers of any late fee or interest rate policies to encourage timely payments.

“During our terms of sale, we put a note in the credit application indicating that we will charge interest to the maximum extent the law will allow,” said Kenny Wine, CCE , director of credit at Joseph T. Ryerson Son, Inc. (Little Rock, AR). “Different states have different usury laws, so there is a maximum you can charge a customer. We put language in there as another tool to leverage and facilitate a conversation to correct the problem. It is not necessarily a free revenue generating source for us, but it gives us that potential if a customer does not pay us for a year and we had to take them to court, we could get the cost of capital back during that time.”

Yet many B2B credit professionals struggle to successfully collect late fees, and some do not use it as a tool at all. A recent?eNews?poll revealed half of creditors do not charge late fees. Of those who do charge, 33% are successful in collecting only a quarter or less of late fees. “When dealing with late payments from consumer businesses such as a car payment, it was fairly easy to collect fees back in the day,” Wine said. “But when I got into the B2B world, customers were less likely to pay the late fees or interest if charged.”

How to Enforce

Include specific language that covers potential late fees and interest in multiple documents so there are no questions. Make sure that language is repeated in your credit application, order acknowledgement, invoice and terms and conditions. Phrases like “Highest percent allowable by law” will give your credit department the most flexibility when collecting fees, especially for those selling to customers in different states. But you also can get more specific by using the phrase “Invoices not paid within X days are subject to a finance charge (or service fee) of X% per month.”

For example, if you set an annual interest rate of 12%, the monthly fee for your customer would be 1% (12% ÷ 12 months = 1% per month). If a customer is late on a $100,000 invoice, they would be charged an extra $100. Do not describe any fees or interest as a “penalty” because it could backfire if you need to go to court.

Customers should be made aware of your late fee policy ahead of time to avoid awkward conversations. It is equally as important for you as a credit professional to hold your late-paying customers accountable. Follow through on charging late fees whenever possible, or at least notify the customer that you intend to charge a fee if they do not pay the owed amount.

“We’re successful in collecting about 50%-75% of default interest,” said Jason L Mott, CCE , NACM Board director and corporate credit manager at MFA Incorporated (Columbia, MO). “For some customers, we may settle for smaller payments only because we need to take what we can get versus not taking anything at all—which increases the opportunity to lose everything. We make the business decision to take what we can get.”

When and When Not to Charge

If your company is in a cash crunch, reminding customers about your finance charge policy could help get payments in the door quickly. But it is crucial to remember the complexity of the creditor-customer relationship in the B2B space.

Deciding the appropriate situation to charge fees is a delicate balancing act. For example, you do not want to ruin a positive relationship with a customer who is unable to pay due to factors beyond their control. “We were being asked to waive some interest fees for some customers because low river levels prevented them from delivering crops to the end user, which is not really their fault,” Mott said.

Have a conversation with your customer before jumping straight to charging a fee. Doing so will help decrease tension and maintain a positive relationship. But in extreme cases “where the relationship has already gone downhill and we’ve obtained a judgment, we then have the right to garnish bank accounts and pull from paychecks involuntarily.”

An alternative to charging late fees is offering a small discount for early payments, which might be beneficial as we head deeper into rocky economic waters. “Our repayment history has been pretty good over the last couple of years, but I see the potential for that to change this coming year,” Mott said. “I think it’s going to be very interesting to see what our repayment history is going to be this coming year.”