In the simplest of terms, employers hire employees to perform a job. Once that job has been performed, employees expect to be compensated for their efforts. At least that’s how payment in arrears works. 

What’s payment in arrears? Well, it’s a common payment method used daily by landlords, consultants, publishers, and thousands of other industries. Keep reading to discover how this concept works and why it’s an essential service for individuals and businesses alike. 

What Does Paid in Arrears Mean?

According to Merriam-Webster, an arrear (commonly used in plural form) is defined as the state of being behind in the discharge of obligations; an unfinished duty; or an unpaid and/or overdue debt. 

For those new to payroll or accounting, the term “paid in arrears” may sound complicated. Luckily, it really isn’t. Payment in arrears refers to an arrangement where compensation for goods or services rendered is made after the work has been completed or the service has been provided. In other words, the payment is made retrospectively, typically at the end of a specified period, rather than in advance. 

Payment in arrears is commonly used in various financial contexts, such as salaries, rent, or subscription fees. For example, if employees are paid in arrears on a monthly basis, they receive their salary at the end of each month for the work they performed during that month.

Payment in Advance vs. Arrears

Payment in advance and payment in arrears are two contrasting payment terms with different implications for cash flow and risk management. Generally, one offers payment before a service is performed and the other afterwords. Let’s take a deeper dive.

Payment in advance involves offering compensation before goods or services are delivered. This provides assurance a seller will receive payment upfront, granting him or her a sense of security and reducing the risk of nonpayment by the purchaser. While payment in advance can be advantageous to a seller’s cash flow, it may deter potential buyers who prefer to pay after receiving the goods or services. 

Payment in arrears requires payment to be made after the goods or services have been delivered or completed. This allows a buyer to inspect the goods or services to ensure they’ve been adequately delivered. This compensation method offers flexibility for the buyer, as payment is made only after the purchaser or recipient has an opportunity to approve the goods or services rendered.

How Paid in Arrears Works

A payment in arrears may be intentional, due to the wording of a contract, or unintentional, in the case of a late payment. 

In the context of payroll, a payment in arrears is the most common form of payroll. This method rewards employees for work that was completed in a previous pay period. For example, if you pay employees on the second and fourth Fridays of the month, this payment is for work done in arrears (that’s already occurred). 

Industries that commonly use payment in arrears include:

• Construction: In construction projects, contractors often use payment in arrears to ensure work is completed satisfactorily before disbursing payments. Payment milestones are established based on project completion stages, such as foundation laying, framing, and finishing.

• Software as a Service: Software as a Service (SaaS) companies, such as OnTheClock, often use subscription-based models with payments made in arrears. Customers are billed at the end of their subscription periods for the services they've used during that period. 

• Property Management: Landlords and property managers commonly collect rent payments in arrears, with tenants paying for their occupancy during the previous rental period.

Understanding Payment Schedules

Earlier, we mentioned numerous payment schedules. Let’s take a further look at each a few of these options in more detail. 

• Payment in Advance: In this arrangement, payment is made before goods or services are delivered. This provides assurance to the seller or provider but might present a risk to the buyer or receiver if the goods or services fail to meet expectations. This method is commonly used in industries, such as retail, event planning, travel, and more.

• Payment on Delivery: Payment is made at the time the goods or services are delivered or executed. This is common in retail and small-scale transactions, where payment is required immediately. This approach is commonly used in conjunction with courier services, freight and shipping, food delivery, etc. 

• Payment in Installments: In this scenario, the total payment is divided into incremental amounts that are made over a period of time. This approach is common for larger purchases, like vehicles, education, homes, vacations, and more. 

• Recurring Payment: These are regular payments made on a recurring basis. Oftentimes, this approach is used for membership-based services, like gyms, utilities, or software licenses, such as OnTheClock.

Examples of Arrears in Action

Here are a few scenarios that illustrate exactly how a payment in arrears works. 

• Employee Salaries: Many companies pay their employees on a biweekly or monthly basis for work performed during the preceding pay period. For example, if Steve works Jan. 1-13, and he is paid for this work on Jan. 14, he is being paid in arrear. 

• Rent Payments: Tenants often pay rent to landlords at the beginning of the month. For example, if Steve pays rent on April 1 for his stay in the month of March, this is considered a payment in arrears. 

• Subscription Services: Customers are often billed at the end of the month for services they received the previous month. For example, if Steve subscribes to OnTheClock, he’ll be charged an invoice at the end of the month for the services he utilized throughout that month. 

• Freelance Services: Freelancers often complete work before they are paid. For example, if Steve is contracted to write blog posts for your business, he will do so and then submit an invoice; therefore, he is then paid in arrears for his services. 

Leveraging Time Tracking for Arrears Payment Success

Time tracking software can help facilitate accurate and efficient payment in arrears by providing transparency, automation, and streamlined processes. Modern time tracking apps allow employers to record work hours with precision, capturing start and end times, breaks, and tasks performed. Some apps, including OnTheClock, offer real-time visibility for managers, detailing who’s punched in, where they currently are, employee work hours, project progress, and more. Additionally, time tracking software can automate the calculation of billable hours, integrate payroll processing, create automated reports and invoices, and much more. 

Advantages of Arrears Payments for Businesses

Payment in arrears offers several advantages for businesses. Let’s take a look at several of the reasons why. 

Improving Cash Flow Management

Payment in arrears allows businesses to use goods or services, or execute a deed, before making payments, which can help in managing cash flow more effectively. This delay in payment provides businesses with additional time to allocate funds to other operational expenses or investments. 

Motivating Employees Through Payment Strategies

When employees know their compensation is tied to their performance, they are likely to be more motivated to deliver high-quality work. Payment in arrears encourages employees to prioritize tasks, meet deadlines, and strive for excellence to ensure timely payment. 

Enhancing Payroll Accuracy

Payroll administrators have more time to verify and reconcile employee time records when using a payment-in-arrears approach. This additional time allows for thorough review and validation of timesheets, reducing the likelihood of errors when calculating hours worked or wages owed, and minimizing the risk of overpayment. 

Minimizing Overpayment Risks

Paying after goods or services are delivered reduces the risk of paying for items or services that do not meet expectations. As for payroll, payment in arrears allows accounting to calculate exactly how much to pay, including overtime and absences. Rather than guessing or paying in advance and later adjusting the payroll, payment in arrears allows the accounting department to issue checks for the exact number of hours worked. 

Considering the Drawbacks

While payment in arrears offers several benefits, it also comes with its fair share of drawbacks that both buyers and sellers should be aware of. Understanding these cons can help businesses make informed decisions about their payment practices.

The Financial Impact on Employees

While having its advantages in certain contexts, payment in arrears can also have negative financial implications on employees. Employees relying on regular income to meet their financial obligations may face cash flow challenges when payments are delayed. And, if payments arrive after the work has been completed, employees may find it challenging to budget effectively. This uncertainty can lead to financial stress and instability, leading employees to lean on credit, loans, or other forms of borrowing. 

The Effect on Motivation and Engagement

A delay in gratification may reduce the immediate sense of reward and recognition employees feel for their efforts. Without the assurance of when they will receive their wages, employees may struggle to plan and work toward their objectives, resulting in a lack of direction and purpose in their work. And, when an employee feels undervalued or unappreciated, engagement levels may decline. They may become disengaged from their work, leading to lower productivity, creativity, and overall job satisfaction. 

For example, consider Sarah, a single parent, who is working full-time as a waitress. She relies on her biweekly paycheck to cover rent, child care, and groceries. If/when her paycheck is late, she struggles to pay rent, risking eviction and late fees. This financial stress and uncertainty may lead her to seek a new job with a more reliable pay schedule. Additionally, the added personal stress may impact her efficiency and productivity at work. 

Navigating Administrative Hurdles

To manage payment in arrears schedules, businesses must maintain accurate cash flow forecasts, plan for potential fluctuations, and establish contingency funds to cover expenses during lean periods. Additionally, accounting reps must ensure the payment schedule complies with labor laws, minimum wage regulations, and any other relevant statutes. 

To combat this a company may consider offering financial literacy workshops or various resources to help employees budget, plan for expenses, and cope with potential cash flow challenges. Empowering employees with financial knowledge can reduce stress and improve their overall well-being. 

Payroll Schedules Demystified

Payroll schedules dictate when employers issue compensation and employees receive their wages. Let’s take a look at a few common payroll schedules.

Weekly vs. Biweekly vs. Semi-Monthly

• Weekly: In a weekly payroll schedule, employees are paid every week, typically on the same day. This frequency provides employees with consistent income but may require more administrative effort to maintain. 

• Biweekly: Biweekly payroll occurs every two weeks, resulting in 26 pay periods per year. Biweekly schedules offer a balance between weekly and monthly schedules, ensuring employees are compensated frequently enough to manage a family budget while relieving some of the administrative burden on an internal HR team. 

• Semi-Monthly: Semi-monthly payroll schedules involve two pay periods per month, typically occurring on (or around) the 15th and the last day of the month. This schedule results in 24 pay periods per year and provides a predictable payment structure. 

The Rationale Behind Payments in Arrears

Ultimately, payment in arrears is a common practice in various industries. Withholding payment until goods or services are delivered ensures each party is satisfied with the arrangement. For employers, paying in arrears provides an opportunity for managers to evaluate performance before disbursing compensation, encouraging accountability and satisfactory performance. For employees, payment after the fact incentivizes workers to perform their best before receiving compensation. Knowing their payment is contingent on performance encourages employees to maintain high standards of work quality and productivity.