If you haven’t read the introductory article to recurring billing mini-series, as well as the article on basic recurring payment features, you are welcome to do so, as it will improve your understanding of the current post.
While in the previous article we described the basic concepts and features, related to recurring payments, in this one we are going to address several fundamental billing paradigms, used within the architecture of recurring payment systems. Respective fundamental features play a critical role within the payment system. If they are missing, they cannot be easily added (basic features can be rapidly implemented or some “work around” can be found). Therefore, when selecting your recurring payment partnership, it is important to explore these aspects, if you feel that they are important or necessary for your business.
When a business decides on the recurring payment system that it wants to use, it needs to determine the billing paradigm that applies to its current business model. There are two paradigms used to organize recurring billing systems, which can be referred to as repeat billing and recurring billing. They are often associated with two different accounting methods – cash-based and accrual-based method.
Account billing paradigms
Repeat billing
Under repeat billing paradigm there is no accumulation of outstanding balance or debt-ageing mechanism, i.e., if a payment is unsuccessful, the amount is not somehow stored or added to any outstanding balance sum. Repeat billing (which can also be referred to as cash-based) approach is a simpler one of the two. It is most often used, when uncommitted billing is involved and no form of collections process is used. If the customer stops paying, the service simply gets terminated. Examples of businesses using this approach include web-sites offering various types of services, such as dating web-sites.
Recurring billing
Recurring billing (which can also be referred to as accrual-based) paradigm is more complex than repeat billing. It involves both invoices and payments. Invoices are used to recognize outstanding balance, while payments are used to balance out the invoices. Recurring billing paradigm is more suitable for businesses that maintain past due balances and age debt, tend to reattempt unsuccessful payments and, potentially, report unpaid balance to credit bureau. Consequently, this approach has the capability for such features as automated fee surcharges (including late fees). If a payment is missed the service continues, but the follow-up process is launched. Examples of implementation of this approach are gym membership or car-leasing.
Those who rely on recurring billing and, therefore, maintain accounts receivable (AR), are often concerned with a specific balancing algorithm that is used to apply payments to the outstanding invoices. For certain types of businesses, such as billing companies, it matters a lot, which of the outstanding invoices and fees a collected payment is going to close, and in which order.
Account balancing methodology
Balancing happens only within the context of recurring billing (see above); it is the process when payments are balanced against the invoices. Depending on the business context and contract terms, there are 3 common ways of balancing accounts that are used.
- Oldest invoice first – Whatever payment is collected is applied to the oldest outstanding invoice. Most commonly used in collection process when funds are collected for past due payments.
- Newest invoice first – whatever payment is collected is applied to the most recently created outstanding invoice. Most commonly used in automated draft process.
- Oldest invoice first, followed by service fees, followed by remaining invoices – often used by third-party billing companies that service accounts on behalf of other businesses. According to the agreement, they, generally, keep all of the service fees and, therefore, have an incentive to collect them as soon as legally possible.
Let us now see how each of account balancing methods works on the same terms of an agreement.
Example
- Under oldest-invoice-first approach, the payment will cover $50 invoice for January, $50 invoice for February, and two $25 late fees for January and February
- Under newest-invoice-first approach, the payment will cover $50 invoice for March, $50 invoice for February, and two $25 late fees for March and February
- If the health club works with a billing company, then this company is going to charge service fees and keep them. Consequently, under the third approach the payment will cover the $50 invoice for January and the three late fees, while the remaining $25 will get applied to the February invoice
Another important feature is the ability to accommodate multiple payment arrangements, including different payment schedules, payment options etc.
Important advanced features of recurring billing systems
While many legacy systems have support for recurring billing they share a common flaw. Very often they are unable to maintain multiple products under a single account, because in a legacy architecture, by definition, an account could support only one payment arrangement (payment plan) and one form of payment (credit card or bank account).
The problem is that some people like to have a backup payment method in case the first one does not go through (credit card plus bank account). Others may like to pay with their credit card for one service and with their bank account for another (but they still want to have access to both services under the same customer account).
Consequently, the following capabilities of a recurring billing system must be considered while deciding on your integration strategy:
- Support for multiple payment plans (arrangements) under a single customer’s account. This feature is particularly relevant for businesses that have a primary form of subscription or membership that customers sign up for, and then offer add-on services. The problem with systems which do not support multiple payment methods under the same account is that the only option to sell these add-on services is to pay in full for that.
- Support of multiple payment options (methods) under the same account.
Example
In the next article we are going to describe various aspects of collections process.
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