Advance and Arrears: Understanding the Differences Means Good Business Decisions

Something that comes along with all the conversation about the gig economy trend is the issue of billing and payment. There are basically two ways to get paid – in advance or in arrears. While just about everyone understands the idea of getting paid “in advance,” not everyone understands what “arrears” is and how billing in arrears works. There is the stigma that arrears is bad. There is a reason for that. But understanding the differences is important for the financial success of small businesses.

Payment in advance and cash flow

Cash flow is the life blood of every business. Having money coming in regularly means the business can function and pay out money while waiting for payments to come in. Because billing in arrears generally means that you will be paid AFTER work is completed, it means that any expenses that occur during the work period must be paid by other funds.

Because that is not always a tenable practice for small businesses, they often go with other payment methods. Some of those might include:

Payment in advance – Payment will be made, in full, before work begins, or at the outset of a project. While this looks like a great deal for vendors, some customers are reluctant to pay in this manner. You can see why: what if the work is not completed, or not completed satisfactorily? There must be a very high level of trust for this type of arrangement to work.

Initial deposits or down payments – This arrangement allows for the vendor to pay for some of the expenses up front. This is often used when it is obvious there will be expenses, such as in a construction situation where the vendor must purchase supplies and materials.

Scheduled payments – This is often used for projects and contracts that are extensive in length. The vendor has expenses, and the customer sees progress being made. Most often payments are made at certain points, or benchmarks, in the project.

Retainer payments – When a vendor performs a service on a regular basis, payments made be made automatically in advance as a retainer. These are usually in place for on-going services such as cleaning offices, IT services, or bookkeeping. These payments allow both the vendor and the customer to plan and perform consistently.

What does in arrears mean?

Simply, it means payment is behind. And that is where the negative connotation comes from. When someone is behind on their payments, or late in paying, it is said that the customer is in arrears. Being in that kind of arrears is bad. No one wants to be in the position of having payments overdue, or late.

However, billing and getting paid in arrears is different. It means that the billing is not sent, and payment is not made, until after the work is completed. For example:

• Employees may be paid in arrears. They are paid for the time worked AFTER it is worked. The pay period ends on Friday and the employees are paid the following Friday.
• Monthly service vendors may be billed and paid in arrears. A cleaning service provides services for the month of August and then bills their customer for that service period on August 30.
• Contracted vendors may be billed and paid in arrears. You contract to have a website designed and built for your business. After the work is completed and the website is up and functioning, the website designer bills for the work completed.

Now the arrears that no one likes

When payments get behind, they can be said to be in arrears. No one likes to be considered having bills in arrears. The customers don’t like it because of the stress, potential additional costs, and the damage to their reputation. Vendors don’t like it because it cuts into their cash flow, adds costs, and can put them in arrears with their vendors.

If you have payments that are in arrears, or late, it could mean:

• Additional interest fees and late penalties and fees, it can get very costly, fast
• Loss of favorable payment terms – vendors might want payment in advance
• Reduction in available credit for your business – lenders may reduce the funds available to you as your credit rating is damaged
• Forfeiture of business partners – vendors may decide not to do business with you again.

Likewise, if your customers are in arrears, you have the same options. When payments get behind, no one benefits – vendor or customer.

Accurate and timely bookkeeping is critical

The best way to keep cash flow running smoothly, is to have a good handle on the bookkeeping process, whichever type of billing you choose for your business. Invoices must go out to customers in a timely manner and you need to know which invoices are unpaid and in arrears. That allows you to decide what measures to take.

You don’t want to be the company that is left with tens of thousands of dollars in billings pending when a customer business files bankruptcy. Regular monthly bookkeeping keeps you on top of issues that can quickly accelerate into major problems.

You have a lot of decisions to make as a small business owner. Outsourcing your bookkeeping, just like outsourcing your payroll, is a decision that can alleviate many problems for you down the road. The decision to let a company like The Payroll Department take care of bookkeeping and/or payroll is one decision that prevents you from having to make a lot of challenging decisions in the future. It is a proactive step to strengthen your business. That’s because you have professionals taking care of important aspects of the financial side of your company.

When you want to find out more, give the owner of The Payroll Department, Teresa Ray, a call at 317-852-2568. We are here to help you make the decisions that make the future easier to manage.

-Elaine of The Payroll Department Blog Team