The different meanings of "payment in arrears" explained
Payment in arrears has different meanings in different contexts - both positive and negative. We show you here what payment in arrears means and what advantages and disadvantages it has, using common practical examples.
The expression "payment in arrears" means that one is in arrears with a payment. This means that a payment was due at a certain time but has not been made. This can refer to the due date of a bill, or to monthly recurring payments, for example mortgages, rent or other debts. In this context, payment in arrears is negative.
However, payment in arrears can also be agreed between two contracting parties, for example if a company has provided a delivery or service to a customer and then issues an invoice for it. The customer then pays in arrears because the delivery or service has already been provided. In this case, payment in arrears is not a negative term.
The counterpart to payment in arrears is payment in advance. In this case, the two contracting parties agree that payment will be made for a delivery or service before it is provided. This can be the case with monthly internet bills, rent payments or the purchase of trade goods.
In order to refer to payment in arrears, a corresponding clause can be included in the general terms and conditions or agreed individually in the contract with the respective business partner.
For example, a company may set a contract with an IT service provider with the following payment in arrears clause:
Payments for services will be made in arrears only upon receipt of a proper invoice, detailing the services provided. Payments for software subscriptions or licences may be paid annually in advance.
When it comes to payroll, some companies prefer to pay their employees in arrears. For example, if the employment contract states "paid 4 weeks in arrears" or "paid monthly in arrears", an employee will only receive payment for the hours worked in the respective month after four weeks, i.e. at the end of October he will receive payment for October.
For companies, this has the advantage that they can accurately account for the hours worked by their employees and pay the correct social security contributions and taxes.
A company has rented a warehouse. The monthly rent payments are £800 and are always due on the 1st of the month. In March the company's account has insufficient funds so the £800 cannot be transferred. From 2 March the company is in arrears and is said to be paying in arrears. If the company makes a payment of £800 on 01 April as usual, it is still in arrears. This situation continues until the company makes an additional payment of £800. If it only pays £500, it is £300 in arrears.
An IT service provider carries out server maintenance for a company. After the maintenance work is completed, the service provider issues an invoice for £5,000 payable within 30 days. Payment in arrears is therefore expected in this case.
However, if the company does not make the payment within 30 days so that the invoice becomes overdue, it is in arrears until it pays the invoice amount in full.
Whether it is better for a company to agree on payment in advance or payment in arrears with its business partners cannot be answered in a general way, as both methods have advantages and disadvantages.
The advantage of choosing payment in advance for a company is that its customers pay before they receive the delivery or use a service. This puts the least strain on the company's cash flow, as payments are received immediately.
This method is popular in e-commerce and with new customers or business partners with whom you have not yet established a relationship of trust and whose payment practices you do not yet know. With payment in advance, companies also do not run the risk of chasing unpaid invoices.
The disadvantage of payment in advance is that some business partners do not accept this method, for example if the invoice amounts are very high. Agreeing on a deposit and subsequent payment in arrears can then be the better solution if you do not want the customer to switch to the competition.
If payment in arrears is agreed with customers or business partners, this puts a strain on the company's liquidity, because the delivery or provision of a service means that the company receives advance financing. At the same time, however, it must be able to pay its own invoices, for which cash is necessary.
The advantage of payment in arrears is that it allows a company to precisely invoice the hours worked, for example for project or contract work. If a relationship of trust already exists with customers and business partners, payment in arrears is a way of accommodating them, which strengthens their bond with the company.