Paid in arrears is a common practice across the business world. It simply means paying for something after you receive it.
In the world of payroll, paid in arrears means you pay your employees after they complete their work. Choosing to pay in arrears affects your operations in both payroll and accounting. Therefore, it’s important to know what paid in arrears means and the pros and cons of paying in arrears.
What does arrears mean?
At its most basic, “arrears” means “money that is owed and should already have been paid.”1 However, “paid in arrears” doesn’t necessarily have a negative connotation in business. In fact, paying in arrears is common in both the banking and legal industries2. For example, if you pay for a service after its completion, you pay in arrears.
In some contexts, the connotation is negative, such as when your account is in arrears after missing several consecutive payments. Overall, though, the key consideration is understanding arrear’s meaning as it applies to you and knowing whether paying in arrears benefits your business.
What does it mean to be paid in arrears?
Being paid in arrears typically means being paid for work you’ve already completed. Receiving an arrear payment also refers to collecting a bill or liability that is only due after the service is provided, such as an employee salary or property tax. This type of payment is often intentional, in compliance with a contract. However, some arrear payments are unintentional.
Payment in arrears has two possible definitions — either a payment made after the completion of a service, job, or billing cycle (and considered on time) or a payment made after a contracted due date (and considered past due).
Arrear payments are the most common way for employers to pay workers in the U.S. Companies and employers often pay in arrears for several reasons, namely that the extra time allows accounting teams to calculate and run a payroll schedule with more attention to detail. By paying workers after their hours are logged, companies are able to calculate employees’ regular or overtime hours, tips, commissions and sales, paid time off (PTO), and incentive pay.
Another reason companies tend to pay their workers in arrears is to have more flexibility with their cash flows. When an organization pays their employees in arrears, they free up time to pay obligations and earn interest on their cash — a double win.
In reference to running payroll, paying in arrears means compensating an employee for work that took place during a previous pay period rather than the current pay period. For example, if your organization pays their employees on September 30 for the September 1-15 pay period, that’s an arrear payment. The impact of payroll in arrears on employees is quite simple: companies pay workers three to five days after the end of a pay period, not immediately.
What is a pay in arrears example?
To better understand paying in arrears, let’s consider a paid in arrears example. If your $1,000 bill payment is due on September 15 and you miss the payment, you are in arrears for $1,000 the following business day. Even if you continue paying the rest of your bills on time after missing that $1,000 payment, you are in arrears for $1,000 until you make it up or pay whatever sum remains if you pay part of it.
3 types of arrears payments
Three of the most common types of arrear payments are as follows, along with an explanation of each.
Annuity in Arrears
Annuity payments involve equal amounts of cash paid at equal intervals over time3. A mortgage, for instance, refers to regular payments of one amount over a set period of time. If you pay a mortgage in intervals of $2,000 once a month for 30 years, always at the end of every month, then each $2,000 transaction is an annuity payment since it’s being made at the end of the fixed period when it is regularly due.
Dividend in Arrears
When an organization pays their preferred shareholders the dividends they are entitled to after the deadline that both parties agreed upon, that delay is called a dividend in arrears. Usually, a dividend in arrears occurs when an organization lacks the funds they need to make the full payout to their preferred shareholders. Therefore, the organization makes notes about the dividend in arrears in their financial statements and refrains from paying their ordinary shareholders’ dividends until they make up the arrears to their preferred shareholders. Unlike annuity in arrears, a dividend in arrears is a late payment.
Call-in Arrears
When a shareholder delays payment of call money, or funds they are briefly borrowing or lending, past when it’s due, that overdue payment is call-in arrears. To calculate call-in arrears, deduct the amount of the borrowed sum that’s been paid off (paid-up capital) from the total amount due (called-up capital). If the shareholder forfeits the unpaid call money, the organization issuing that money to the shareholder has the option to recover it.
Other Common Types
In addition to the three common types of arrears payments listed above, consider the following list:
- Featured partners
- Down payments
- Retainers
Ultimately, it’s clear that there is a wealth of arrears payments to consider when determining best payment practices for your employees.
Payment in arrears vs. in advance vs. current
Depending on when an organization makes a payment relative to when it’s due, that payment is either in arrears, in advance, or in current. Payment in arrears refers to a payment made after a good or service is provided. For example, if your organization’s payroll corresponds with the previous work period rather than the current one, that is an arrears payroll.
Paying in advance is the opposite of paying in arrears, which is to say that advance payments are made before a good or service is provided4. When an employer pays workers ahead of the normal pay schedule, that payment is in advance. Another common example of an advance payment is a retainer. Retainers are a work-for-hire payment model—as opposed to a pay-for-performance model—that independent contractors like lawyers typically use, soliciting payments before their service begins.
One of the main benefits of choosing to pay in advance is that it grants your organization more flexibility with cash flow, which can be especially useful for small business owners. A major downside to paying in advance is that it only works if your customers are willing to place their full trust in your services without guarantee. Advance payments aren’t easy for start-up companies that have yet to build trust with their clients.
Paying in current falls between paying in arrears and paying in advance. Companies that pay their workers in current pay them the very same day the current pay period ends. Paying in current requires employers to calculate the estimated hours their employees are scheduled to work during the upcoming pay period or workweek before payday. Doing so is easier with full-time employees and slightly more difficult with hourly employees who use timesheets.
One benefit of paying in current is that it is likely to increase employees’ understanding of and satisfaction with your organization’s payroll system. One tricky aspect of paying in current is that it forces companies to guess how many hours their employees work during a pay period, which is not always the same as the real employees’ hours, ultimately requiring pay adjustments.
Paid in arrears pros and cons
Just as paying in advance or in current has advantages and disadvantages, so does paying in arrears. Consider the pros and cons of paying in arrears because both impact a business and its employees.
Benefits
Flexible payments
Paying in arrears gives businesses the power to decide when payments are due. Building a flexible payment schedule is more convenient for companies and takes some of the pressure off the payroll distribution process.
Longer time to calculate payroll
Companies that pay workers in arrears have more time to consider important factors such as overtime, PTO, payroll taxes, commission, tips, and benefits.
Higher accounting accuracy
One of the natural benefits of providing employers with more time to calculate payroll is improved accounting accuracy. With a looser payment schedule, accountants have more time to collaborate and double-check that their organization’s invoices match the goods received, thus saving their organization money by preventing refunds and overcharges.
Lower risk of paying for incomplete work
Paying in arrears guarantees companies a high return on every dollar they pay out because it eliminates their chance of paying for work that’s not performed, while if you pay upfront, you may lose out.
Disadvantages
Past-due payments
Late payments have the potential to constrict the cash flow of companies that bill in arrears. Companies that complete work before receiving any payment after they billed in arrears sometimes struggle to fund immediate operations and waste time and energy trying to secure late payments.
Income losses
Companies who pay in arrears risk losing revenue due to a client’s missed payments or financial troubles. Recovering payment from accounts in arrears is an uphill battle.
Late payment risks
Increased risk of falling behind on payments often upsets employees, who deserve on-time compensation for their hard work. Additionally, employees have to wait extra time to receive payments compared with payments in advance or in current.
Paying in arrears and accounting
Payments in arrears impact accounting and its role in business, not just payroll. In an accounting sense, paying in arrears refers to two different concepts—either paying a contractor or service provider for goods or services after your organization receives them as agreed to or making a late payment to a contractor or vendor.
If a contractor allots a payment term of net 30, your organization has 30 days to pay for the contractor’s services, so you’re paying in arrears as agreed upon. However, if that contractor allocates a payment term of net 30 and your organization pays after the 30 days are up, your arrears payment has a negative connotation because it means that your organization fell behind on its scheduled payment. Paying in arrears when it comes to a business is not necessarily the best choice as it affects a business’s cash flow.
A word from the experts: 4 tips to pay in arrears
Follow the following recommendations when paying in arrears, and your bosses will thank you.
Audit your accounts
In scenarios such as payroll distribution, an agreed-upon payment in arrears is a useful tool that gives businesses extra time and flexibility. Paying in arrears when there’s no such agreement is frowned upon. To make sure you are up to date on your organization’s payments and avoid falling into arrears-territory, conduct regular audits of your accounts payable.
Keep tabs on organizations that pay you
Receiving all your organization’s payments in arrears is sometimes a slippery slope. Allowing your clients to make payments in arrears has the potential to send the message that your organization doesn’t need the payments.
Keep tabs on client or partner’s pending payments
When a client or partner is in arrears on payments to your organization, consider suspending any further business negotiations with them until they make those payments in order to protect your business.
Request down payments
Down payments help your organization manage cash flow by helping guarantee that your clients are paying off their arrears.
FAQs around payments in arrears
Does arrears mean late?
Yes, arrears means late payments. Arrears payments are either past-due or simply made after the provision of a good or service.
Is being in arrears always negative?
Paying in arrears doesn’t always carry a negative connotation. In bond trading or payroll, for example, arrears refers to payments made at the end of a certain period rather than payments made after a due date.
Why would a paycheck be paid in arrears?
Many companies choose to pay their workers in arrears because it gives them flexibility with their cash flow, simplifies payroll, and helps ensure accuracy in accounting.
What does paid one week in arrears mean?
One week in arrears means your organization pays employees seven days after the week during which they completed their hours.
To learn more about best payment practices, check out Payscale’s suite of best-in-class software, comprehensive data, and beyond. With knowledge like the insights found in this article and beyond, we can make pay a powerful thing.
