One of the biggest challenges that a small business owner can ever face is not having enough money to pay employees. Delaying payroll affects employee morale and your ability to retain key individuals. This article discusses how to use payroll financing to meet payroll and keep the business growing. We cover:
- The most common problem
- The payroll challenge
- What is payroll financing?
- Advantages and disadvantages
- Is this solution right for you?
The most common problem
Small businesses with commercial or government clients often run into cash flow problems. Commercial clients usually ask for net-30 to net 60 day payment terms. In most cases, this clause is non-negotiable. It gives your client 30 – 60 days to pay an invoice.
The small business has to cover all the upfront costs of delivering the product/service to the client by using its cash reserves. After servicing the client, the small business needs to wait a month or two to get paid back. This situation creates two problems.
The first problem is that most small businesses have razor-thin cash reserves. A small financial problem could send it into a tailspin. The second problem is that it affects the company’s ability to grow and take on new clients.
For example, assume the small company receives a very large order. Usually, that would be a cause for celebration. However, the small business may need to deplete its cash reserves to pay the upfront costs of servicing a large order. In this situation, taking a large order is risky and leaves the company exposed to financial problems.
Some small companies try to handle this problem by asking clients for a pre-payment. In other cases, they offer clients an early payment discount as an incentive to pay quickly. These strategies can help, but they don’t provide reliable cash flow.
2. The payroll challenge
Payroll is one of the largest expenses for small businesses. In some cases, such as service companies, staffing agencies, and security guard companies, payroll is the largest expense. It is also one of the most difficult costs to manage. As opposed to some vendor costs, payroll cannot be negotiated down or delayed. It comes due regularly and must be paid on time.
One of the worst scenarios a small business can face is being unable to pay employees. There are no good options at that point. In most cases, the business will go into a downward spiral and fail. The best strategy is to plan ahead and avoid this problem. One solution that can help you do this is payroll financing.
3. What is payroll financing?
Payroll financing allows you to leverage your accounts receivable and improve your cash flow. It’s commonly implemented using invoice factoring or a similar solution. It provides the funds to cover payroll expenses, which enables you to operate and grow the company.
a) How does it work?
The most popular way to create a payroll financing plan is to use invoice factoring. Factoring enables you to sell your invoices to a finance company that pays for them immediately. This provides you with the funds to cover payroll and other business expenses.
Most factoring transactions are structured as the sale of your accounts receivable in two installments. The first installment is called the advance and is deposited into your account when you sell the invoice. The advance covers around 90% of the invoice’s value.
The remaining 10%, less the factor’s fee, is deposited into your account when your end customer pays the invoice in full. This second installment concludes the transaction for that invoice.
b) How much does it cost?
The factoring fee is based on the volume you want to finance, the size of the invoices, and the credit quality of your customers. In most cases, it goes from 1.15% to 3.50% per month, though costs vary. To learn more, read “How much does factoring cost?”
4. Advantages for small businesses
Payroll financing has several advantages over other small business financing solutions.
a) Allows you to offer net-30 day terms with ease
A factoring line allows you to offer net-30 to net-60 day terms to your clients without worrying about your cash flow. The solution enables you to turn invoices into working capital very quickly.
b) Can be set up quickly
Invoice factoring lines can be set up relatively quickly. In some cases, the client gets their first funding in as little as five days. The application process is straightforward and only requires that you provide basic business information and reports.
c) Available to small business owners
This solution is available to small business owners that cannot qualify for conventional bank financing. To qualify, companies must have:
- Customers with good commercial credit
- Unencumbered invoices
- No serious tax problems
Learn more about the qualification requirements for invoice factoring.
d) Grows with the business
The financing line is flexible, and your available funds are based on your qualifying accounts receivable. The line can grow as your sales grow.
5. Is it right for your small business?
Payroll financing is not the right solution for every business. However, it can help your company if your:
- Cash flow problems are due to slow-paying clients
- Clients pay in less than 60 days
- Profit margins are above 15%
Get payroll funding!
We are a leading payroll funding company and can provide you with a competitive quote. Fill out this form for an instant quote or call us toll-free at (877) 300 3258.
Are there other options?
If you do not work with commercial clients or don’t qualify for factoring, refer to this list for a number of other options.