According to research, 65% of entrepreneurs who fail deem financial mismanagement to be the biggest culprit.
The adage is true that revenue is a rubber ball that bounces back when you drop it, but cash flow management is a glass ball that breaks if you drop it. Unfortunately, running a business and not having cash in the bank despite making sales is a reality for many firms.
As a result, it can become difficult to pay your workers. If you’re facing this situation, payroll funding is one means through which you can source the money to make your payroll and keep staff morale up. Here is an in-depth look at how to finance your payroll.
What Is Payroll Funding?
Payroll funding is a type of short term credit that helps a firm access working capital from which it can pay employees their dues. Since it is short term financing, its repayment is usually within 12 months or fewer.
There are several ways through which you can access the short term credit necessary to finance your payroll. Each form of financing works differently, and you have to determine what best applies to your company.
Invoice factoring, also known as accounts receivables factoring, is by far the most common form of payroll financing available to businesses. In essence, invoice factoring is you agreeing to sell financial rights to your invoices for immediate payment.
When your sales tend to cash in after 30 to 60 days, the delay in payment can stretch the cash reserves at hand. As a result, you can use these invoices to raise the finances you need to pay your team. To do so, you’ll sell your invoices to a payroll financing firm that will purchase them in two installments.
The first installment, also known as the advance, covers 80% to 95% of the value of your invoice. Funds from the first installment will typically hit your company’s bank account within one working day.
The percentage amount of the first installment varies by industry, and each payroll financing firm will use its criteria for this. Some of the standard rates include:
- 60% to 80% for medical companies
- 70% to 75% for construction firms
- 90% to 92% for staffing organizations
- 90% to 95% for trucking businesses
Once your customers settle their invoices, the payroll finance firm will send you the remainder of the money minus their financing fee.
With invoice factoring, the cost of payroll financing will depend on several factors. These include the creditworthiness of your customer and the number and size of the invoices you plan to factor.
The essential thing to note is that invoices can only qualify for factoring if there are no liens or encumbrances on them. Moreover, invoices that stand a high chance of receiving factoring should be from reputable government agencies or private companies.
Business Line of Credit
A business credit line is a form of financing that allows you to withdraw funds as many times as you need until you hit your limit. You can continue making withdrawals from a business credit line as long as you pay back previously drawn amounts. As such, it is a revolving form of credit.
When you want to get a business line of credit for payroll financing, an online lender will probably be a better option. Such lenders give you the funds within one to three days, whereas traditional banks can take a few weeks.
A business line of credit works best as a payroll financing tool if you anticipate recurrent need but don’t want to keep reapplying.
With that said, business lines of credit come with varying terms depending on each lender. Therefore, before you take one out, you need to scrutinize the fine print and consult your accountant.
It’s common to receive terms such as 20% to 40% on repayment over a few months or years. On top of that, some lenders tend to treat each draw as a separate loan and charge you fixed monthly rates for it. In the grand scheme of things, such an arrangement might become costly.
Short Term Business Loans
A short term business loan is a form of credit that offers a lump sum amount you’ll pay back in one to three years. In contrast to business lines of credit, short term business loans are easier to qualify for. These loans also offer you more funds than a business line of credit.
You can receive a short term business loan in as little as 24 hours, which makes it an excellent option if you need to meet payroll in a week or less.
Short term business loans also make for a better payroll financing option if you don’t anticipate a recurring need that can necessitate repeated borrowing.
For small businesses, a Small Business Administration (SBA) microloan is an excellent alternative in this category. Aside from the friendlier terms you can receive as a small business, SBA microloans also come with consulting services to help you solve payroll problems.
How Much Does Payroll Financing Cost?
The type of cost you should bear in mind when looking for payroll financing depends on the option you settle for.
Generally speaking, invoice factoring can cost you between 1.15% and 3% per 30 days. The larger your company is, the lower the discount you can receive.
When using short term business loans, the total cost of capital is critical in determining if the financing makes sense. Therefore, loans with shorter terms and higher interest rates become more affordable than those with longer terms since you pay a lesser amount in total.
On average, business lines of credit can cost you between 13.99% and 40%, while short term business loan financiers can charge between 9.99% and 50% interest.
Meet Your Payroll Without Fail
When you run a business where your sales cash in every 30 to 60 days, it’s easy to find you don’t have enough money to pay your staffers. Payroll funding is a tool you can use to monetize your invoices or assets and access the funds you need to pay your staff. Consult your accountant as you assess each payroll financing option to find out the most cost-effective approach for your firm.
Do you want to gain more insight into how to get your business on a better operational footing? Check out more of our content for actionable ideas that help streamline your business.