What does arrears in accounting mean?
Reading Time: 4 minutesWhen a service is delivered and the agreed payment day is missed, or the pay comes after the due date, it’s said to be in arrears in accounting.
It isn’t always an overdue payment; it could also mean that a good or service is being paid for after the service is completed.
Arrears in accounting could be bills, services, utilities, employee benefits, loan repayments, etc.
Your business can receive arrears from customers or make payments in arrears to their vendors.
Types of Arrears in Accounting
Arrears are grouped into three:
- Call-in arrears
- Annuities in arrears
- Dividends in arrears
Call-in arrears
This situation occurs when the shares of a company are distributed among shareholders, and the due date for payment is missed.
If any shareholder fails to pay the call money within the fixed date, the amount not paid is called Calls-in-Arrear.
It is calculated by deducting the paid-up capital from the called-up capital.
Annuities in arrears
An annuity is a financial transaction that occurs at regular intervals in equal amounts over a given time: e.g., a Mortgage payment.
An annuity in arrears occurs when the scheduled payment is made at the end of the time interval rather than at the beginning.
An example is a loan repayment with installments due at the end of each calendar month.
Dividends in Arrears
Preferred Shareholders of a publicly traded company are often entitled to dividend payouts irrespective of the company’s profit or loss statement.
When the company fails to make the cumulative payout to preferred shareholders, dividends are said to be in arrears.
The company is also restricted from making any payouts to common shareholders until it settles dividends that are in arrears.
What does payment in arrears mean?
This is when your company pays for goods or services after receiving them. It is common practice with salaries and payments to vendors. Payments are only made to employees at the end of the service delivery.
With vendors, you could work with a company that invoices you with a payment term of net 30/60/90. This means you make a payment after receiving the service or product.
You will be paying in arrears.
You may have also heard it referred to as “invoice in arrears,” “bill in arrears,” or “arrears billing.”
Examples of Payments in arrears include but are not limited to postpaid phone service, postpaid water bills, postpaid gas bills, etc.
What are the advantages of payment in arrears?
- It reduces the risk of inaccurate payments. While billing in advance may raise an issue of refunds in case you overcharge a customer. On the other hand, if you undercharge, you will have to issue multiple bills.
- It’s less complex and more convenient to access service delivery. In payroll, it eliminates the wrong estimation of employee work hours.
Disadvantages of payment in arrears?
- You open your business to the chance of falling behind in payments, which could hurt the balancing of books. Try to keep a few payments in arrears, such as payroll, rent, and utilities.
- Employees may not like waiting for a couple of days to get paid.
What does a bill in arrears mean?
Bill in arrears means that you only charge your customers after a service or good is provided.
Small business owners usually prefer billing in arrears as it allows them to factor in every delivered service that may have been missed at the start of a project. This helps avoid miscalculations that may lead to overcharging or undercharging customers.
For example, a freelance graphic designer who sends in a design and has clients make a lot of alterations or requests more variations as against what was earlier agreed on would be much easier to accommodate by billing in arrears.
Also, most customers prefer paying for a good or service after seeing the final result.
Disadvantages of billing in arrears
- It could raise cash flow issues because your company won’t receive payments immediately.
- It increases the chances of bad debts as clients may likely default after providing them with total goods or services. Some of the factors could be customers having financial difficulty, they forgot or they didn’t receive an invoice.
How to reduce the risks of arrears in accounting
- You should conduct a credit check on clients to ensure they’re creditworthy and in good financial standing.
- To limit the risks of cash flow problems, you can require a deposit or down payment from clients.
- Ensure you track your invoices, set reminders, and resend when necessary using accounting software like Akaunting.
- Suppose a client has accumulated a lot in arrears. In that case, you can consider pausing your business arrangement until the payment obligations are fulfilled or a new agreement is created to avoid bad debt risk.
Final thoughts – Is billing in arrears good for your business?
As earlier highlighted, billing in arrears isn’t necessarily bad for your business. It opens up an opportunity to acquire more customers and be competitive in an increasingly credit-based market.
That said, deciding to bill on arrears also depends on your industry and compensation history. If your findings reveal that businesses in your niche don’t experience financial setbacks, it’s probably worth the shot. If that isn’t the case, you may want to opt for upfront payments.
For accurate tracking of your bills and invoices, it’s best to choose accounting software that saves you productive time as you stay on top of your income and expenses. Get started with Akaunting.
