The Ultimate Guide to Payroll Financing

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Last updated: 06/29/2020
The Ultimate Guide to Payroll Financing

Companies in Need of Payroll Financing

Payroll financing is often what smaller, growing business turn to when there’s a gap in the cash flow. It’s relatively common for a new business just getting on its feet to require this method of financing. Payroll funding is also typical for a company that isn’t very big or may have seasonal sales. In the slower months, is without the reserves to finance their payroll for their employees.

Alternatively, companies can experience rapid growth that gets ahead of them. The cash flow gap widens. A rift between expenses quickly becomes expansive, and suddenly, payroll is exceedingly more difficult to meet. Funds are designated elsewhere, but payroll, being as important as other expenses, still must be met. 

With commercial sales processed on terms that extend to Net-30 days or some even Net-60 days, the problem quickly becomes customers dragging their feet on making payments. When terms are pushed, payments are delayed, and invoices become outstanding, companies struggle. In the case of seasonal sales, spurts of growth or cash flow gaps, late-paying customers are the final nail in the coffin that ultimately send companies on their search for lenders.

These are the situations where companies turn to lenders experienced in payroll financing. No matter what their financial situation, most companies in need of payroll financing will have outstanding invoices that can be utilized as a means of asset-based lending to achieve payroll funding. This is called invoice factoring, and it intertwines with payroll financing as a way to resolve the cash flow gap.

How Does Payroll Financing Work?

Employees must be paid regularly and on time. It’s part of their contract and yours as the business owner. Failing at this task will mean your employees and staff will undoubtedly leave the company if they aren’t getting paid. Plus the slew of liabilities that comes along with breaching a hiring contract you’ll want to surely avoid. 

Payroll financing is the solution that gives you as the business owner the ability to pay your employees even if your company is struggling with cash flow issues. It works by means of financing a company’s invoices, which as previously discussed, is called invoice factoring, or accounts receivable financing. 

However, other methods can be utilized for payroll funding. For example, lenders can finance a company’s assets if they are considerably valuable and the company has enough assets to fund a loan for working capital.

Invoice factoring is the most common approach for payroll financing solutions. Your company agrees to sell its collection of accounts receivable invoices to the payroll financing company. This payroll funding company will then in turn, purchase the outstanding invoices in separate installments, issuing two separate payments for the transaction.

The first installment is called an advance. The payroll financing company issues a payment for the outstanding invoices that usually covers between 80%-95% of the value of the invoices. 

Of course, every lender is different and will offer different terms for their advances and payroll financing. You’ll know the exact figure if you decide on contracting with the lender. These funds, as provided to you by your payroll financing lender, are deposited into your bank and made available to you within one to two business days.

The second installment is issued as soon as your customer makes a payment on their outstanding invoice in full. Then, the payroll financing company will pass the payment onto your company, less the financing fee and other agreed-upon charges. Like the first installment, the second will be available within one to two business days at your bank.

How Much Does it Cost?

One of the advantages of payroll financing is that it has a competitive rate structure. A market discount rate can be between 1.25%-2.5% per month but naturally, there are differing rates offered by a variety of factoring companies. Some are even as low as 1% per month. There are also no hidden fees with payroll financing - another advantage of this lending option.

For large companies, even lower rates are available. It all depends on the commercial credit quality of the clients your business invoices and the amount of funds you’re requiring.

The Benefits of Payroll Financing

There’s a reason why payroll financing is so popular. Even when companies aren’t strapped for cash, payroll funding is a widely utilized tool to obtain working capital for fund their payroll.

Eliminates the Dilemma of Cash Flow

First, payroll financing eliminates cash flow issues. This is a helpful perk especially when a company is overloaded with outstanding invoices. A payroll financing steps in and handles the cash flow dilemma for them. Not having to worry about cash flow and meeting weekly or biweekly payroll can lift the stress for a business owner, shifting their focus to other company matters.

Funds Are Ensured to be Available Payroll

Payroll financing is a swift process. For companies in need of capital to make their payroll demands, time is an element they cannot negotiate with. Employees must be paid, and the staff must be paid on time. An employee’s paycheck is not a compromise, and businesses in dire need of funds for payroll cannot afford the luxury of waiting for a loan.

Payroll financing is a successful method because once a factoring company receives the invoices from your borrowing company and collects on them. Those customer payments are issued back to your business’ bank account. You may not have the time to dedicate to your collections, but it’s the purpose of an invoice factoring company to do so on your behalf so both parties are paid.

This may seem like a long process on paper, but if you’re already offering Net 30-day terms to your customers, the factoring company simply ensures that the payments are being collected on those invoices - but with streamlined efficiency. Now, you can turn your focus on paying your employees, expecting funds to be available for every necessary payroll period, without the worry.

Payroll Financing Comes Through Quickly

Because of the method of invoice factoring used in payroll financing, this type of lending has a faster approval period than conventional loans. Your invoices are being used as collateral, and if you should default on your payroll financing loan, the payroll company has something to use as an asset for liability coverage to recoup any losses.

Payroll financing is also easier to obtain than business loans. There’s less paperwork involved in the application process. Lenders care more about the value of your receivables, which acts as collateral, rather than personal credit histories or business revenue.
Finance Guru

Finance Guru