What Does It Mean To Be Paid In Arrears?

Last Updated on September 11, 2023

It’s no secret that being paid late is one of the most common challenges business owners face, especially small business owners operating on tight budgets.

Yet sometimes payments are intentionally made after a service or good has already been provided. There is a term for this kind of prearranged late payment: “paid in arrears.”

Most have likely experienced arrears payments at some point, whether as an employer, employee, seller, or customer. However, since this term isn’t frequently used in day-to-day conversation, let’s look into what arrears means, what it means to be paid in arrears, and some examples of payments in arrears.

What Is Arrears?

“Arrears” is a financial term defined as an overdue payment. While “overdue payment,” may have a negative connotation, arrears is not inherently bad.

When arrears is written into a contract, whether that be in a B2B contract or a new employee contract, this means that payment is expected to be made after a project has been completed. In these instances, the goal is to give a business more time to either come up with funds for the service or to organize the allocation of funds to the provider.

An example of a B2B contract that contains arrears include an invoice with Net 30 payment terms. Since invoices are typically sent after a service has been provided or project has been completed, this is considered an, “invoice in arrears.”

However, many customers are in arrears because they are behind on payments. This can cause serious effects on business operations such as cash flow problems for the service provider.

Not only do customers in arrears hurt their seller financially; they also bring upon unwanted tension to the partnership. From the seller’s perspective, it can be awkward to figure out how to politely pry your customers for payment.

Paid in arrears has two different meanings:

  1. Both parties have agreed that payment is due after a project has been completed or service provided, such as the above example of net payment terms on an invoice.
  2. Payment is past-due or was paid late. This is the version of arrears that all businesses look to avoid, as being paid in arrears in this sense can cause cash flow to decelerate and even affect a business’s ability to make payroll.

The first meaning of paid in arrears is commonly referenced in relation to employee payroll, meaning employees are paid after they have completed work, rather than in advance. For example, a salaried employee may receive a paycheck on May 15th for work completed from May 1st to May 14th. Because they are being compensated after the work has been completed, the payment is made in arrears.

The most common payroll in arrears lengths are:

  • One week in arrears
  • Two weeks in arrears
  • One month in arrears

While employees thankfully don’t have to wait much longer than a few weeks to be paid for their work, there are instances where citizens pay up to one year in arrears, such as when we pay property taxes.

In Alabama, property taxes are due by October 1 each year. That payment reflects owning the title of property for the previous tax year, which runs from Oct. 1 – Sept. 30. Thus, we pay one year in arrears.

Not every state has the same payment schedule for property taxes; for example, New York residents pay in installments through the tax year. Plus, many counties and states allow residents to pay in advance, or to pay in arrears earlier than required (prepay).

Defining paid in arrears can be tricky when it comes to accounting. This is because sometimes, businesses prearrange to pay in arrears, which allows the customer ample time to come up with the cash to pay for the service they bought.

Paid in arrears can also imply that a customer failed to meet payment terms on an invoice, and that the invoice, or bill, is past-due. When arrears is brought up between business partners, it’s important to clarify which meaning of arrears is being referred to.

The following provides an illustration of being paid two weeks in arrears:

You receive a paycheck on May 6, 2023, reflecting work from payment period April 7-21 (you are paid biweekly). Your next paycheck on May 20, 2023 reflects work from payment period April 22-May 6.

You might not be used to this being referred to as “paid in arrears,” as even some HR professionals aren’t accustomed to using arrears in their regular vocabulary. But in the case of your paycheck being “delayed,” that’s actually being paid in arrears.

Moving onto the next example, we see that arrears is not solely used to describe payroll.

Most of us pay in arrears when we pay our monthly electric bills or utility bills. Since those bills typically ask for payment after services have been extended, those bills are being paid in arrears by customers.

Billed in Arrears vs. Paid in Arrears

Billed in arrears and paid in arrears are not the same thing. A business would bill in arrears when they’ve already provided a product or service and are requesting payment. Billed in arrears would typically be referenced by a seller, supplier, or contractor because they are the ones billing their clients for their services.

Paying in arrears means paying for a product or service after it’s been received. Paid in arrears would usually be referenced by the buyer or customer, as they are the party paying for the service.

Payment in advance (or paid in current) means a person or business is paid in full before a job has begun. This differs from paid in arrears in which there is a predetermined agreement between a buyer and a seller that the payment will be made after the services have been provided.

For example, subscribing to a streaming service requires payment in advance, as you’ll typically be asked to pay at the start of each month prior to receiving access to the streaming service. Conversely, if your company uses a marketing agency for an ad campaign, the agency may send you an invoice at the end of the month after the services have been provided, and you would pay this invoice in arrears.

Benefits Of Payment In Arrears

In business, payroll is where paid in arrears is most commonly utilized. Employees, employers, and even staffing agencies should learn the benefits of paying in arrears.

Let’s take a look at some of those benefits of paying employees in arrears:

Eases Time-Sensitive Accounts Payable Stressors

Allowing for one week to one month in between paying your employees can ease the stressors that come with accounting, particularly when dealing with tight deadlines when it comes to making payroll.

It’s common practice to pay employees in arrears, regardless of industry. As long as you’re a responsible business owner and not failing to make payroll, this is an acceptable method.

Allots Time To Calculate Tips for Service Industry Employees

Many service industry employees are paid in arrears by necessity, given much of their salary is earned through tips. These tips cause wages to fluctuate and become unpredictable, removing the possibility for payment in advance.

Since the accounts payable team needs time to count and apply tips to employee wages, payment in arrears comes in handy.

Allots Time to Calculate Commission for Sales Professionals

Arrears isn’t only convenient for paying service industry workers. It’s also beneficial for sales professionals, whose earnings are often heavily reliant on commission. Accounting teams need ample time to tally salesperson earnings each payment cycle.

Small business owners should consider arrears when planning or writing contracts for new employees, particularly when hiring sales professionals such as account managers, account executives, and business development officers.