Calculating late payment interest

Even if you've read our guide to invoicing with success, you may still come across customers and clients that don't pay on time (you may also find our guide to late payers and bad payers handy if so!)

Late payments can create cashflow difficulties, potentially cause you to default on your own debts, and add admin and perhaps interest charges too – not to mention the damage they can cause to your own supply relationships.

For these reasons, if your business sells to other businesses (B2B) rather than consumers (B2C), you have a legal right to charge interest to those who don't pay their invoices on time – but you don’t have to if you don’t want to.

There are two main grounds for claiming interest.

The first is under your contract. Ideally, your trading contract should state within how many days the client must have paid their invoice. It should also confirm that you're entitled to claim late payment interest for outstanding invoices that are not paid on time – and you have up to 6 years to do so..

If you didn't contractually specify a number of days within which your business customers must pay their invoice, you’re legally entitled to treat the payment as late after 30 days of your customer having received your invoice.

But remember, you can only claim this late payment interest if your contract specifically gives you the right to do so.

If you don’t have a clause in your terms, then the Late Payment of Commercial Debt (Interest) Act 1998 gives you a right to ‘statutory interest’.

If you have an interest clause in your trading terms, that should also include the rate charged. The calculation works in the same way as below, but don’t forget to make adjustment for differing payment dates and interest rates.

If you are claiming statutory interest, you can claim interest at 8% above the Bank of England base rate (this varies, so make sure you have the latest figures). For example, if the base rate is 0.5%, you may charge your debtors 8.5%. This starts running starts running 30 days after the latest of delivery, invoice and completion of any acceptance procedure.

These rates are used to calculate a daily rate of interest, which is then aggregated and charged for the total amount of time the payment is late (i.e. from the date the debt becomes overdue up until the date it is paid).

Example

• Your business is owed £2,000.00

• Base rate is 0.5%, so the statutory rate is 8.5%

• The invoice is 90 days old, so the debt is 60 days late

Step 1: Calculate the annual rate; i.e. the debt multiplied by the statutory rate (£2,000.00 x 8.5% = £170.00 per year)

Step 2: Work out the daily rate; i.e. divide the annual rate by 365 (£170.00 / 365 = £0.46 per day)

Step 3: Work out the interest due; i.e. multiply the daily rate by the number of days by which the payment is late (£0.46 x 60 = £27.60)

You may also claim an additional fee for compensation and reasonable debt collection costs. This can be £40 for an overdue invoice of up to £999 in value; £70 for an overdue invoice of between £1,000 and £9,999 in value; and £100 for overdue invoices over £10,000 in value.

First, you need to write to your customer (now called ‘your debtor’), to inform them of the amount of money they owe to you and how this amount has been calculated.

You then need to advise them of the date they need to pay by, who they need to pay, and exactly how they can pay (including relevant bank details).

As well as helping you to claim the interest, this letter will hopefully also encourage prompt payment.

But, if they still don’t pay, you may need to take further action, such as notifying them that you may begin legal proceedings if the payment is delayed further.