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.
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.
Tip: To keep track of payments in arrears, try using an online time tracking tool—it'll help you make sure everyone gets paid correctly!
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.
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:
Earlier, we mentioned numerous payment schedules. Let’s take a further look at each a few of these options in more detail.
Here are a few scenarios that illustrate exactly how a payment in arrears works.
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.
Payment in arrears offers several advantages for businesses. Let’s take a look at several of the reasons why.
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.
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.
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.
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.
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.
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.
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.
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 dictate when employers issue compensation and employees receive their wages. Let’s take a look at a few common payroll schedules.
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.
A payment in arrears is a payment made after a transaction has been completed. This may be intentional, due to the wording of a contract, or unintentional, in the case of a late payment.
If an employment contract is paid four weeks 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 March, the employee will receive payment for work completed that month.
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