Calculating interest on commercial debts

Calculating interest on commercial debts

Charging interest on late payments is not only acceptable but is encouraged in order to evoke change and reduce the percentage of businesses experiencing cash flow problems due to overdue invoices.

Late payment of commercial debts costs businesses thousands every year, and it’s becoming increasingly important to stop late payers in their tracks to support small and medium-sized businesses to keep their cash flow healthy and their business afloat.

Often larger businesses will impose longer payment terms, but you have to think about your business, your cash flow, and payment terms that are acceptable to you. 

This can often mean charging interest on commercial debts.

However, it’s important to know that there are legal rules and guidance on claiming additional late payment charges and calculating late payment interest.

Definition of late payment

A payment is considered late if no money has been received one day past the invoice due date.

If you haven’t specified a payment due date on your invoice, payment is legally considered late beyond 30 days. The only exception to this, is if you have agreed to longer payment terms, which are not grossly unfair to your business.

Day one of 30 begins when the customer receives their invoice or the product or services have been provided in full.

Creditors are protected by law

The Late Payments of Commercial Debts Act 1999 allows creditors to claim 8% over the Bank of England base rate for all business-to-business debts.

In addition, a fixed fee (late payment charge) can also be applied (up to the value of £100).

However, the act is rarely used, and this must change for businesses to survive.

You can implement the Late Payment Act if:

The debt relates to a business-to-business debt

There is no contractual rate of interest pre-agreed

The debt is indeed outstanding, i.e., over 30 days or past the payment due date.

Late payment of commercial debt interest

There are two types of commercial debt interest to be aware of:

Contractual interest – any contractual interest which you want to apply when an invoice is late will typically be stated in pre-agreed payment terms – highlighting the importance of your contracts and the terms and conditions included. It’s important to note, you cannot claim contractual interest without such terms and agreements pre-agreed and signed.

Statutory interest – statutory interest for commercial debts means you have the legal right, as a business creditor, to charge interest for late payment. However, if you have an agreement relating to contractual interest rates, you can only claim statutory interest if your invoices reserve the right.

On top of the interest you can charge, businesses are entitled to charge a fixed late payment fee, added to the cost of recovering late payments of commercial debts. The fee you charge depends on the debt’s size and is set by law, and you can use this option if you opt to outsource the debt collection to a professional debt collection team.

Calculating interest

The statutory interest rate for late payment of commercial debts is 8% plus the base rate set by the Bank of England, which applies to all business-to-business transactions. (It does not apply to consumer transactions).

As an example:

The current base rate is 3%, so the statutory interest for an outstanding commercial debt would be 11%.

Statutory/contractual interest works on a daily rate, and the calculation is as follows:

Debt x interest rate (statutory interest+base rate) x number of days late / 365

For example, a debt of £1,000 which is 15 days late:

1000 x 11% = 110

110 x 15 = 1650

1650 / 356 = 4.52

Additional interest added to the invoice to date now stands at £67.80, so a new invoice should be issued with the new amount owing as £1067.80.

Late payment of commercial debts

When an invoice becomes overdue, it’s often not as straightforward to add interest and reissue another invoice.

You have the customer relationship to think about (however, if a customer is continually paying late, they may not be the right customer for you).

Before jumping in and adding interest from the start, following a robust credit process can help.

For example, the first step is to send a late payment letter outlining the letter’s meaning and the next steps if payment is not received.

If there is still no payment, send a letter before action explaining that interest will now be added as well as a late payment charge, and the outstanding debt will be passed to debt collection services to handle on your behalf. (Make sure to check out our latest post on “Tips on what to do when a customer doesn’t pay.”)

At Direct Route, our team has the experience and tools at their disposal to collect all outstanding commercial debts.

We help to protect the client relationship and successfully collect on outstanding invoices using our robust credit processes and procedures.

To remove the stress and resource strain of collecting overdue invoices from your team, call us today at 0330 229 1991 or email your requirements to – we’d be happy to help.