If you’ve ever dealt with accounts payable or receivable, you might have seen the term ‘paid in arrears’ before. Although the term might sound technical, its meaning is straightforward. What does paid in arrears mean when used in accounting? Keep reading to find out its definition and whether the term applies to your business.
What does paid in arrears mean?
When a payment is made after a transaction has completed, it’s said to be paid in arrears. Sometimes this is intentional due to the wording of a contract, and sometimes it’s unintentional when a client makes a late payment. The term ‘in arrears’ applies to both payments you make and receive. For example:
If you send out a bill after you’ve provided a service, you’re billing in arrears.
If you pay for a service after it’s been received, you’re paying in arrears.
Paid in arrears meaning in payroll
Arrears are frequently used in the context of payroll. Here, it refers to paying an employee for work that was completed in a previous pay period rather than the current period. For example, imagine that you pay employees on the fifth of March for work that was completed during the full month of February. Because the employees receive their paychecks after the work has already been completed, it’s paid monthly in arrears.
Many businesses choose to set up a payroll calendar this way. When employees are paid monthly in arrears, it gives the business time to calculate tips, commissions, and overtime hours. The alternative is to pay ‘in current’ which means that employees are paid for the projected number of hours that they’ll work. Rather than relying on a timesheet of hours completed, the business pays for what it assumes the employee will complete.
Paid in arrears meaning in accounting
Paying in arrears takes on a slightly different meaning in accounting. When you pay for goods and services after they’ve been received, they’re paid in arrears. For example, imagine that you purchase services from a vendor with net 30 payment terms. This means that you have 30 days to submit your payment after receiving the service. The vendor chooses to be paid in arrears with the terms built into their contract or invoice. Paying in arrears gives your business added flexibility and boosts cash flow. With more time to pay, you can make more sales to generate cash for payments.
However, sometimes this also refers to late payments that haven’t been agreed upon. When your business is behind on the bills, this means it’s in arrears until you’ve completed payment. Paying in arrears isn’t a good thing in this context. You may have to pay late fees and your reputation could take a hit.
Pros and cons of billing in arrears
We’ve discussed paying vendors in arrears, but what about billing your own clients? Billing in arrears refers to charging customers after they’ve already received the good or service. For example, if you’re a graphic designer you might submit your invoice after you’ve already completed a project for the client. This carries certain benefits, including greater billing accuracy. You’re less likely to under or overcharge for the job and have greater flexibility to arrange a payment plan with new clients.
On the other hand, your cash flow might suffer if you have to wait longer for payment. There’s also the chance that your client will refuse to pay, in which case you’ll need to pursue debt collection. Billing in arrears works best with established, trusted customers.
Is income support paid in arrears?
While employee payroll is often paid in arrears, what about government benefits? Is income support paid in arrears? There’s some flexibility with this type of payment plan and income support is just one example. In this case, claimants can choose weekly advance payments or more staggered payments in arrears. PIP payments are paid every four weeks in arrears, as are state pensions.
Whether looking at payroll, benefits, or accounts receivable, paying in arrears gives an organisation more time to calculate payments and ensure their accuracy. Yet this practice should be used with caution when it comes to accounts payable, as overdue payments can quickly spiral out of control and result in poor client-business relationships. Consider using accounting software to manage your payments, whether current or in arrears.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.