Calculating late fees on invoices can be straightforward, but applying the calculation consistently and building a policy around it can be more challenging. Most companies have late fee terms in their contracts, but the enforcement of these terms can be inconsistent, leading to weakened policies over time.

Understanding Late Fee Structures

There are three common late fee structures: flat fees, percentage fees, and annual percentage rate (APR)-style interest. Each structure has its own advantages and disadvantages, and the choice of structure depends on the specific needs of the business. A flat-rate fee can be simple to apply, but may not be proportionate to the size of the invoice. A percentage fee can be more proportionate, but may be more complex to calculate.

The formula for a flat late fee is simple: Late fee = flat amount × number of late periods. For example, if a customer owes $800 on an invoice with a $35 flat late fee, the total due after one late period is $835.00. If the fee applies per billing cycle and the invoice sits unpaid for three months, the total fee is $105.00, bringing the balance to $905.00.

Percentage Late Fees

A percentage late fee applies a monthly rate to the outstanding amount. The formula for a noncompounding percentage fee is: Late fee = original invoice amount × monthly rate × months overdue. For example, on a $5,000 invoice with a 1.5% monthly rate, the fee is $75.00 per month, always calculated against the original $5,000.

With compounding interest, the formula shifts: Balance after N months = original invoice × (1 + monthly rate)^N. For example, on a $5,000 invoice at 1.5% monthly, month one can produce $75 in interest, bringing the balance to $5,075. Month two calculates against $5,075, producing $76.13 in interest, bringing the balance to $5,151.13.

Original reporting: KEYT (Ventura/Santa Barbara) — read the source article.