Most staffing companies are launched by entrepreneurs who have a vision but little start-up capital. The companies operate on tight cash flows for their first few years as they grow the client roster. However, growing a company with a tight cash flow is challenging and carries significant risks. All it takes are a couple of late payments, and you could find yourself unable to pay employees.
This article discusses how to finance a technology staffing company using payroll financing. This solution improves your cash flow and helps ensure you have the funds to handle payroll. We cover:
- Payroll vs. revenue
- Early payment discounts
- Payroll financing
- Advantages of payroll finance
- Limitations
- Does your company qualify?
1. Payroll vs. revenue
Technology and knowledge workers are in high demand and command high salaries. These salaries are one of the reasons technology staffing companies can also have high revenues. However, high salaries also affect the staffing company’s expenses. This scenario results in a fast-growing company with a high expense load.
a) Net-30 terms cause cash flow problems
Staffing agencies often give their clients net-30- to 60-day terms to pay their invoices. The staffing agency must cover all expenses while waiting for invoices to pay. However, your staff expects their salary every week or two. Your staff must be paid before your end client pays their invoice.
The funds to cover payroll must come from your company’s cash reserve. This situation is not a problem as long as your cash reserve can cover payroll. Companies without an adequate cash reserve are exposed to financial problems.
In extreme cases, a few late payments are all it takes to send the company into a financial spiral. This type of cash flow problem usually affects small and midsize staffing agencies. However, it can affect large companies as well.
2. Early payment discounts
Staffing companies with minor or infrequent cash flow problems can improve their working capital by using early payment discounts. Early payment discounts provide a discount, usually 2%, to clients who pay in ten days or less. Clients always have the option to decline the offer and pay the total amount on their usual terms.
Some staffing agencies may be tempted to offer this benefit to their slowest-paying clients in the hope they will pay quickly. Unfortunately, this strategy typically backfires and can have unintended consequences. A better strategy is to offer this option to only your best clients. They are more likely to take the benefit, and you can use it as a way to improve your relationship with your client.
a) Limitations
While early payment discounts are great, they have one significant limitation. Your client chooses whether they want to take it or pay on their usual terms. Consequently, these discounts don’t provide predictable cash flow.
Your clients may also stop using this option during difficult economic times as a way to protect their cash flow. During such times is exactly when you are likely to need these quick payments the most. Staffing agencies that need more reliable cash flow or are growing quickly should consider payroll financing instead.
3. What is payroll financing?
Payroll financing is a specialized form of invoice financing designed for staffing agencies. It helps improve the staffing company’s working capital by financing invoices from creditworthy clients. This financing provides the funds you can use to cover payroll, hire additional staff, and grow the company.
a) How does it work?
Most programs finance your accounts receivable by purchasing your invoices rather than giving your company a loan. This structure has some advantages, which we will discuss later on.
Payroll financing companies buy your invoices in two instalments. The first instalment is called the advance and covers up to 90% of the invoice. It is deposited to your bank account shortly after your finance the invoice. The remaining 10%, less the finance company’s fee, is deposited into your account once your client pays the invoice in full. This payment settles the transaction.
4. Advantages of payroll financing
Payroll financing has several advantages that benefit technology staffing companies. The following six advantages are popular with staffing agencies:
a) Solves working capital problems
The most important benefit of this solution is that it solves working capital problems created by slow-paying invoices. It provides predictable cash flow, which improves financial stability.
b) Has high advances
Advances for the staffing industry usually start at 90% instead of the 80% to 85% that is typical for other industries. The higher advance provides your firm with a larger cash cushion.
c) Allows you to offer net-30 terms with confidence
The factoring line enables staffing agencies to offer net-30-day terms to clients confidently. The company has the option to factor the invoice as soon as the work is completed, ensuring they get paid by the factoring company promptly.
d) Adaptive line that grows
Factoring lines are tied to your accounts receivable from a creditworthy client. The line can easily adapt as your revenues from quality clients increase. If additional underwriting is needed, it can usually be completed within a day or two.
e) Easy qualification requirements
Payroll financing lines usually have easier qualification requirements than comparable bank loans. They are available to small and growing staffing agencies.
f) Can be deployed quickly
Lines can be deployed quickly, in as little as five days, if due diligence and deployment go smoothly. The solution can be used by companies that have immediate cash flow needs.
5. Limitations of payroll finance
Payroll financing has two limitations that technology staffing company owners must evaluate before deploying the solution:
a) It solves a single problem
Payroll financing is designed to solve cash flow problems that originate from slow-paying invoices. It won’t help much if the company has cash flow problems due to other reasons, such as low profitability or clients with credit problems.
b) Comparably expensive
Factoring is more expensive than a bank line of credit of comparable size. Cost can range from 1.5% to 3.5% per 30 days, depending on volume and other underwriting criteria. The solution works best for companies with 20% profit margins and whose clients pay in less than 60 days.
6. Does your company qualify?
Qualifying for a factoring line is relatively simple. Since the factor is usually buying your invoices, the factor does not need to perform the exhaustive due diligence commonly associated with loans. Factoring companies focus on the following four areas:
a) Creditworthy commercial clients
Your clients must have good commercial credit. They need to have a track record of paying other vendors on time for amounts that are similar to or higher than what you bill them.
b) No encumbrances against accounts receivable
Your company’s accounts receivable are the main collateral because they have been sold to the factoring company. The invoices cannot be encumbered by liens or hypothèques.
c) No risk of immediate insolvency
Factoring can be used in turnaround situations. However, the company cannot be at risk of immediate bankruptcy.
d) Experienced management
Factoring companies evaluate the background and character of the business owners. This evaluation is important because the owners are the ones who run the business and are ultimately responsible for it.
Get more information
We are a leading provider of factoring in Canada and can offer technology staffing companies with competitive terms. For information, get a quote or call us toll-free at (877) 300 3258.