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Understanding Arrears: Meaning & Calculations Explained

Anyone who runs their own business understands the importance of keeping business finances harmonious. That doesn’t necessarily mean being an overly-cautious spendthrift. It takes money to make money, after all, and carefully planned capital investments can be crucial in taking your enterprise to the next level. However, any business owner worth their salt understands the need to pay suppliers and creditors promptly, and expect the same from clients, customers and other debtors. 

This is the essence of maintaining healthy cash flow, maintaining good relationships with suppliers, and ensuring that employee morale remains high. Making it quick and easy to make and receive payments is a key part of the puzzle. But you also need to ensure that finances are carefully managed in order to avoid arrears. 

You’ve probably already come across terms like “arrears” or “payment in arrears”. Here we’ll explain everything you need to know about arrears, payment in arrears and how arrears are calculated.

What are arrears? 

Arrears can occur in many aspects of your personal or work life. We can fall into council tax arrears, or arrears with your utility company. In business terms, the most common definition of arrears is an unpaid payment that is overdue. Whenever you are behind on any payment, you are classed as being “in arrears”. 

Arrears can also refer to your employees’ salaries. If you pay them in the first week of February for work that they carried out in January, you are paying them in arrears. 

Arrears aren’t necessarily a bad thing. Indeed, there are many industries where making payments in arrears is unavoidable. In the hospitality industry, for instance, staff are often paid in arrears because it allows employers to factor things like shared tips or overtime hours into their pay.  

What is payment in arrears? 

“Payment in arrears'' simply means paying a supplier for goods or services after they have been supplied or rendered. If you hire freelancers, for instance, it’s very likely that all the payments you make to them will be in arrears. 

However, maintaining a healthy cash flow means that you need to carefully manage the balance between collecting payments from people who owe you money, and ensuring that arrears do not occur as a result of missed payments. These can put a squeeze on your cash flow, as they usually come with penalty fees. 

How do you calculate arrears?

There are a number of benefits to paying employees in arrears. It allows for fairer, more even and accurate payment, not to mention making cash flow easier to manage. In payroll terms, arrears are basically increments of salary carried over to the month of payment from the last.

In order to accurately calculate arrears payments for employees, you need to do the following:

  • Start with the employees’ regular monthly salary.

  • Calculate the amount from the end of the previous month up to the appropriate arrears date.

  • Subtract the amount that you have already paid until the arrears effective date.

  • The remaining amount gives you the arrears component.

  • Add on any extras like overtime, tips or bonuses.

Managing arrears effectively

Because of their deferred nature, arrears can either make or break your business cash flow. Business owners need to remain vigilant and prevent arrears from creating a situation that involves late charges, inaccuracies in employee pay and other things that could reduce liquidity and alienate employees. 

Here are some tips to help you manage your arrears effectively:

  • Audit your accounts payable to ensure that no missed payments slip through the net.

  • Keep track of how quickly your debtors pay you. If they often lapse into arrears, it may be considered a red flag.

  • If a client falls too deep into arrears, you should suspend your business dealings with them until their account is current. Otherwise, they could cost more than they generate in the short term.

We can help

If you’re interested in finding out more about arrears, making or accepting payments in arrears, or anything to do with business finance, then get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.

GoCardless is used by over 55,000 businesses around the world. Learn more about how you can improve payment processing at your business today.

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GoCardless (company registration number 07495895) is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration number 597190, for the provision of payment services. GoCardless SAS (23-25 Avenue Mac-Mahon, Paris, 75017, France), an affiliate of GoCardless Ltd (company registration number 834 422 180, R.C.S. PARIS), is authorised by the ACPR (French Prudential Supervision and Resolution Authority), Bank Code (CIB) 17118, for the provision of payment services.