What Does It Mean To Be Paid In Arrears?

Paid In Arrears Payment

Last Updated April 5, 2024

Small business owners handling accounting processes for the first time might be overwhelmed at the amount of unfamiliar lingo that comes with the new territory. One particular term that can cause confusion is, “paid in arrears,” as it takes on multiple meanings that differ based on context.

Some might have a negative connotation of arrears payments, while others might see arrears as a beneficial payment term. This is due to the fact that arrears in payroll, for example, offers benefits to the relevant payees that arrears in accounting, for example, do not.

So let’s look into what arrears means, what it means to be paid in arrears, and some examples of payments in arrears to help clear up any confusion surrounding this complex term.

What Does “Arrears” Mean?

“Arrears” is a financial term inherently defined as an overdue payment. While “overdue payment,” may have a negative connotation, arrears has become a term that can also be defined as paying for goods or services after they’ve already been provided.

Arrears are often written into contracts, such as B2B transactions, insinuating 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.

To recap, paid in arrears takes on 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.

To better understand, it’s helpful to take a look at occurrences where these different meanings are used. Most notably, the following:

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 illustrations are examples of common situations where an individual or entity is paid in arrears.

Arrears in Payroll

You receive a paycheck on May 6, 2023, reflecting work from payment period April 7-21 (you’re 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 two weeks in arrears.

Invoice in Arrears

You’re working with a freelance accountant to help take some paperwork off your shoulders when running your small business. You and the accountant have agreed to a contract with net 15 payment terms, meaning you owe them payment within 7 days of being invoiced for their services. Since you’re paying for services after they’ve already been provided, you’re working on a paid in arrears arrangement.

Past-Due Paid in Arrears

You’re not on arrears terms, but instead, “Due Upon Receipt” payment terms, meaning you owe your supplier payment immediately after receiving a receipt for the goods or services provided.

However, you don’t have the cash on-hand to meet payment terms and are unable to pay for the services and uphold your agreement. The receipt thus becomes past-due, and you’re now in arrears. This is the unwanted version of being “in arrears,” and will likely incur late payment fees.

Billed in Arrears

You receive and pay your monthly gas, electric, water, and utility bills on April 1 for services provided from March 1-31. Since that bill is asking for payment after services have been extended, you’re paying that bill in arrears.

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 Arrears Payments

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.

More Efficient for HR or Payroll Professionals Than Current Payroll

This additional time for calculating employee wages makes life easier for human resources or payroll workers. These slight variances can include overtime wages, tips, commissions, tax deductions, PTO, and sick leave.

Because of this increased assurance of accuracy, processing arrears payroll is typically smoother than current payroll, where employees’ paychecks reflect work from their current period rather than their past period.

What does it mean to be paid one week in arrears?

Being paid one week in arrears means that payment is due exactly one week after goods, services, or other work has been provided.

What does it mean to be paid two weeks in arrears?

Being paid two weeks in arrears means that payment is due exactly two weeks after goods, services, or other work has been provided.

Are salaried employees paid in arrears?

Yes, salaried employees are often paid in arrears. These employees are paid for week based on a previous work “period”, typically two weeks or one month after the work has been completed.