Essential guide to interest on late payments

Late payments create cash flow problems and can increase the risk that you will not be paid at all. Using your legal right to claim interest from late-paying customers can encourage customers to pay on time.

The statutory right to interest and compensation applies to all contracts. You need to decide whether to enforce your rights, and if so how.

The right to charge interest

The rate of interest

Should you charge interest?

When is a payment late?

Calculating the interest

How to claim interest

What if a customer objects?

Further help

1. The right to charge interest

Every business has a statutory right to charge interest on late payments

• The right applies to sales to business and public sector customers.
• The right does not apply to sales to consumers.

You can negotiate your own contractual agreement instead

• The contractual agreement must provide a 'substantial remedy' if the customer pays late.
• The customer cannot impose unfair terms: for example, contractual payment periods are usually capped at 60 days.
• Public sector customers must pay within 30 days and interest on late payments cannot be lower than the statutory amount.
• In the absence of any specific payment terms, the statutory right will apply.

Interest starts being chargeable from the end of the agreed credit period

• If you have not agreed credit terms, normally a payment is late after 30 days.

2. The rate of interest

The law gives you the right to charge interest at the Bank of England base rate plus 8%

• For example, if the base rate is 0.5%, you could charge interest at 8.5%.

Rates for calculating interest are fixed for six-month periods

• The base rate on 31 December is used for debts becoming late between 1 January and 30 June. The rate in force on 30 June is used from 1 July to 31 December.

You can also claim reasonable debt recovery costs

• You can claim £40 for debts of less than £1,000, £70 for debts between £1,000 and £10,000 and £100 for debts of £10,000 or more.
• If your costs are higher than this (for example, if you are using a debt collection agency) you can claim 'reasonable' recovery costs.
• You can only claim these costs if you are claiming the interest due under the Act. If you do not claim interest, or you claim it under a contractual provision or the provisions of a different Act, you cannot claim the costs.

3. Should you charge interest?

Although the rate of interest is high, the total amount of money involved may only be a few pounds. Think what charging interest and costs might do to your relationships with your customers.

Consider how customers are likely to react

• Determine if late payment is limited to a few of your customers, or if most of your customers pay late.
• Ask front-line employees (eg in sales) for their opinions.

Assess the effectiveness of your credit control system

• If you are ineffective at collecting money owed to you, customers may strongly object to being asked to pay interest and debt-recovery costs.
• Make sure you are using a credit control system that is appropriate to your business needs.

Find out what other businesses in your industry are doing

• Your trade association may be able to provide advice.
• Ask your customers if their other suppliers charge interest on late payments.

It is not compulsory to charge interest or debt-recovery costs

• You retain the right to define your own terms and conditions.

4. When is a payment late?

Under normal circumstances, you will have agreed with your customer when payment should be made. The maximum contractual payment period that can be agreed is usually 60 days.

A payment is late if it is made after the last day of the agreed credit period

• Agreements may be verbal or in writing. Verbal agreements are harder to prove.

If there is no agreed credit period, the law sets a default period of 30 days

• You can charge interest 30 days after you delivered the goods or provided the service, or 30 days after you notified the purchaser of the amount of the debt, whichever is the later.
• To notify the purchaser of the amount of the debt, you should ideally send an invoice. But any other form of notification would do, including a phone call - though that might be difficult to prove in the event of a dispute.

Standard practice payment terms may have become established

• This is accepted as the credit period in the absence of any other agreement.
• For example, if the purchaser usually pays you on the last Friday of the month after the month in which you send your invoice, this is when the credit period will end.

The exact wording of your agreement will determine when interest can start

• If you have agreed on part payments triggered by the completion of part of the work - for example, finishing the foundations of a building - interest will start running from the day after you have reached that milestone.
• This is not the same as an advance payment or an instalment (which is not tied to a specific milestone). Interest on these starts the day after the goods are delivered or the whole job has been finished.

5. Calculating the interest

Calculating the interest due is a straightforward, step-by-step process.

Calculate the interest

• Multiply the amount owed by the rate of interest (base rate plus 8%). For example, if the debt is £1,000 and the base rate 4.5%, then the interest would be £1,000 x 12.5% = £125.
• Calculate the daily interest by dividing the annual interest by 365.
• Work out the amount due multiplying daily interest by the number of days late. For example, if the £1,000 debt were paid 30 days late, you could charge 34p x 30 = £10.27.
• You can use the interest calculator on the Small Business Commissioner website.

Any part payment normally goes towards reducing the interest owed first

• For example, if you received payment of £1,000 in respect of the £1,010.27 now being charged, the amount outstanding would be £10.27 of the original debt. Interest on the £10.27 would continue to accrue.
• This does not apply if you have agreed otherwise with your customer.

The amount outstanding changes on a daily basis

• Be practical, as payer or payee, about settling the debt.
• For example, agree that if the debt is paid within one week, then no further interest will be charged.

Your VAT position is unaffected

• You charge interest on the gross amount of the debt (including any element of VAT), but you do not pay VAT on this interest.
• Nor do you pay VAT on any debt-recovery costs you claim.

6. How to claim interest

If you decide to charge interest on late payments, you need to make provision for it as part of your routine credit control system.

Even if you do not intend to collect interest, draw attention to your rights in your 'terms and conditions' statement. It may encourage customers to pay on time.

Notify each customer in writing

• State that you will charge interest on late payments as you are entitled to do by law.
• Contact habitual late payers to discuss how the system will affect them. Explain that their late payments cost you money.

Ensure that your customers understand and agree to your payment terms

• State the agreed payment date on each of your invoices.
• The invoice should clearly state your terms and conditions, and that you intend to exercise your right to charge interest on late payments.

Inform customers when interest begins to accumulate

Give the following information:

• the original invoice number;
• what account the bill is for;
• how much is owed;
• the extra amount of interest the customer will owe you each day;
• to whom the payment should be made;
• payment instructions.

Present the customer with a final bill once everything has been paid

• The final bill should specifically mention the number of days that interest has been charged for and the base rate that was used in calculating the interest.

7. What if a customer objects?

Despite the law, your customer may be unwilling to pay interest on late payment - but they cannot 'opt out' of doing so. In the interests of customer relations, try other ways of obtaining your money before considering legal action.

Make it clear that you would prefer to come to an agreement regarding the debt

• If you cannot reach agreement with your customer, you can follow several approaches to obtain the money.

Consider applying pressure by placing the customer on a stop list

• You stop making further sales to the customer until the debt has been paid.

Consider selling or passing the debt (or part of it) to a third party

• For example, you might use a debt collection agency.
• The purchaser of the debt can use the courts to obtain payment of the debt and the interest.
• If you sell or transfer a debt, you must inform your customer in writing that it has been assigned to a third party.

You may ultimately want to pursue your claim through the court

• Your claim will be helped if you can provide written evidence that you delivered the goods or completed the job, and that the customer was satisfied.
• If you have legal expenses insurance, this should encourage a non-payer to pay up when threatened with legal action.

8. Further help

Further advice on claiming and paying interest on overdue invoices is available from a number of sources.

The Small Business Commissioner

• If you are struggling with late payments from customers, contact the Small Business Commissioner. They offer a free service to help you set up effective credit control in the first place and then pursue any customers that are withholding payments that should contractually have been paid. Their interest calculator is useful, too.
• This independent public body was set up to tackle late payment practices in the UK.

Your accountant or financial adviser

• They should have an understanding of the legislation and how it could affect your business.

Your local business support organisation or trade association

• If you are a small or medium-sized enterprise with up to 250 employees, your business association - such as the Federation of Small Businesses or the Forum of Private Business - may be able to go to court on your behalf to challenge unfair contract terms.

Expert quote

"Businesses need to weigh up the decision to charge interest on late payments. While it is a legal right, any move could have implications for ongoing business relations." - Glenn Collins, Association of Chartered Certified Accountants