As a business owner, you know that sometimes, payments come in late. And if you’re a contractor, you’re probably already using a “work first, get paid after” system.
Taking delayed payments, whether intentional or not, can also be called “paid in arrears.”
In this article, we’ll cover the pros and cons of being paid in arrears, compare it to paying in advance, and provide examples to show how it all works. By the end, you’ll know if running your payroll in arrears is right for your business.
Understanding Arrears
Arrears has two meanings. It describes a situation where a payment hasn’t been made by its due date, meaning a payment is late. But “in arrears” can also describe payments made after a service has been provided. If you receive a service first and then pay for it at the end of the month, that payment would be in arrears.
A common example would be your utilities. You don’t pay for your usage when the month starts—you pay for what you used when the month ends.
To understand the definition of arrears, consider these points:
- Arrears means a payment is late
- It applies to any regular payment that has missed its due date
- It also refers to payments made after receiving a service
So, What Does Paid in Arrears Mean?
Being paid in arrears means you’re being paid for work you did in the past.
Most employers run payroll in arrears. They pay employees at the end of a fixed period for the hours they worked until payday.
RELATED ARTICLE — Demystifying Retroactive Pay: What You Need To Know
What does “interest paid in arrears” mean?
For loans or mortgages, “interest paid in arrears” means the interest is paid at the end of the period it covers, instead of the beginning.
This is common with mortgage payments, especially when each monthly payment includes interest from the previous month.
FROM ONE OF OUR PARTNERS — Billing In Arrears: What Does Arrears Billing Mean Vs. Paid In Advance?
What About Being Paid in Advance?
Receiving pay in advance means you get your money at the start of the pay period.
This means you get paid faster, which can help with your expenses and budgeting. But your boss has to guess how many hours you will work. If they guess wrong, they might pay you too much or too little. They will have to fix this next time they pay you.
If you’re a contractor, you’d probably be paid the price of the estimate. That means if your final amount worked is under the estimate, you have to refund the client some money. That’s why being paid in advance isn’t always the best option.
RELATED ARTICLE — How To Ask for a Deposit “Politely” as a Contractor
Pros and Cons of Being Paid in Arrears
Many companies use the payroll in arrears method, and there are good reasons for this. But like any system, there are some downsides, too.
Pros of being paid in arrears
- Paid time off (PTO), benefits, and taxes are calculated accurately before running payroll.
- Getting your paycheck in arrears reduces mistakes in calculating hours worked.
- When using the payroll in arrears method, there’s less risk of paying for uncompleted work.
Cons of being paid in arrears
- Payment in arrears may take a bit longer to process, which can lead to a delay in getting paid.
- Late payments can have a negative impact on cash flow and business relationships.
- Being paid in arrears can make it challenging for employees to manage personal budgets and expenses.
- It can be inconvenient for new employees waiting for their first paycheck.
3 Real-Life Payment In Arrears Examples
Here are a few real-life examples that show the positives and negatives of getting a paycheck in arrears.
Scenario 1: Luca
Luca works for an electrical company that uses the payroll in arrears method.
He takes a few days off for vacation. Because his employer calculates PTO, benefits, and taxes after each pay period, there are no errors in his paycheck. His time off is deducted properly. He gets exactly what he earned, including accurate PTO deductions.
In this scenario, Luca is quite pleased to get paid in arrears. There are no missed calculations or money that’ll need to be deducted from his next paycheck. This is an issue that could arise when being paid in advance.
Scenario 2: Javier
Javier is a new employee at a roofing company that uses payroll in arrears.
After working his first two weeks, he realizes he won’t get his first paycheck until the end of the month. This delay in payment makes it tough for him to cover his immediate expenses.
Payments are processed after the work is completed, but there was an error in recording his hours, leading to a late payment.
In this scenario, payment in arrears makes life stressful for Javier as a new employee. Budgeting is an issue that employees need to consider when accepting work that is paid in arrears. And late payments can make financial situations even more complicated.
Scenario 3: Wei
The painting company Wei works for uses payroll in arrears.
One month after starting, Wei unexpectedly had to take a week off without notice. The payroll is calculated after work is done. So Wei’s employer only pays her for the time she worked, avoiding overpayment.
This scenario again shows being paid in arrears in a positive light. Wei’s employer only pays for the actual hours worked. This prevents overpayment and helps accurately manage payroll.
Is billing in arrears right for me?
While you might not get to choose how you get paid as an employee, you could negotiate a paid in advance method. And if you’re an independent contractor, you can choose to bill clients before or after your work.
Here are some things to help you decide if this is the right payment method for you:
- Your Budget. Do you have an emergency fund for any unplanned expenses? If you’re relying on your paycheck to have access to cash, you might prefer to get paid in advance.
- Spending Habits. Do you have consistent expenses that make it easier to predict how much you’ll spend each month?
- Clear Payment Terms. Can you set clear payment terms in your contracts, including due dates and penalties for late payments?
- Credit. If you’re an entrepreneur, before agreeing to bill in arrears, try to check your clients’ credit. This ensures they are financially stable and more likely to pay on time.
- Invoicing. Can you send invoices as soon as the service is provided or the billing period ends to encourage fast payment?
FROM ONE OF OUR PARTNERS — What Are Pay Periods, and How Do They Work?
Streamline Your Payments With Joist
Managing your finances is essential for your business’s success, whether you use paid in arrears or not. With Joist, you can make collecting payments the easiest part of your business. You’ll cut cash flow delays, save time on tracking payments, and collect down payments on-site.