Payroll financing works by funding a firm’s invoices and is typically known as invoice factoring or accounts receivable financing. During slower months, small or seasonal companies often lack the reserves to cover employee payroll.
Payroll financing provides these small business owners the capacity to pay employees even if their company struggles with cash flow issues.
Understanding how payroll financing works will depend on the type of financing you choose. Though invoice factoring is one of the most common payroll financing solutions, other methods can be utilized, including lines of credit, merchant cash advances (MCAs) and short-term loans.
Invoice Factoring for Payroll Financing
Invoice factoring is limited to invoice-based firms that have creditworthy clients. It is often structured like a loan that is contingent on your company’s financial asset.
- Your business sells its accounts receivable invoice collections to a payroll financing company. The financing company, in turn, purchases your unpaid invoices in separate installments, sometimes making more than one payment to cover the transaction.
- Choose which invoices you want to present to the factoring company.
- The factoring company will total up the owed amount on those invoices. Once everything has been added up, your company will receive anywhere from 80-90% of the entire invoiced amount you can use to cover payroll.
- The invoice factoring company generally works directly with your customers when it comes time to collect invoice payments.
- As soon as your customers are paid up, the payroll funding company settles the transaction. They do this by depositing the remaining invoice balance, minus a 1-3% financing fee, into your business bank account.
How Lines of Credit Can Finance Payroll
If you have a line of credit with your bank, credit union, or an alternative lender, you may be able to utilize it to finance your company’s payroll.
You can typically draw on your line of credit up to a maximum amount for a specific time. You pay back interest only as you borrow on your line of credit. As soon as it is paid back, that amount is available to borrow again.
An available line of credit can provide peace of mind during lean times, knowing you can cover payroll if you need to.
If you don’t yet have a line of credit, you will often need a minimum personal credit score of 680, $25,000 in annual revenue, and at least six months in business to qualify.
How a Merchant Cash Advance Can Cover Your Payroll
When you choose a Merchant Cash Advance (MCA), a lump sum is deposited into your business bank account, which you can then use to finance your payroll.
An MCA provider grants you funding based on your company’s sales volume. They are paid back with a portion of your firm’s revenue. The amount you will pay in fees is contingent on your business’s ability to repay the MCA.
A factor rate is a multiplier that determines how much the MCA will cost you and is based on your risk assessment. That calculation is added to the entire financing amount, even if your business recovers and doesn’t use the money.
How Payroll Loans Work to Finance Payroll
There are times when taking out a loan may be the only way to meet payroll obligations. Many business owners want a short-term advance to cover expenditures and pay them back quickly. It’s crucial to be straightforward with your lender regarding your ability to repay and about your financial needs. Not doing so can complicate your financial situation.
Answering the following questions can help steer you toward the right solution for your situation:
- What is your business or personal credit score?
- Can you manage a quick repayment, or will you require a longer-term solution?
- How much will you need to cover your payroll?
Though taking out a loan to cover payroll is not the best idea, there are times it becomes a necessary evil to get you out of a tough spot. You have to ensure your employees are paid; otherwise, you could face legal issues on top of a negative impact on workplace morale.
Speed is essential for securing payroll financing because your workers depend on a specific payday. Applying to an online fintech bank for a short-term loan is generally the best option for business owners who need money quickly.
If approved, online lenders can often have money in your account by the next business day. After that, the loan is repaid over a short time. Short-term loans provide competent backup for unplanned financial situations.
Yet, for many business owners, the upfront costs and credit history required for approval can put this form of payroll financing out of reach. Without the good/excellent credit score and collateral that is often expected, business owners like you are denied the funding you need. Because of this, small businesses struggling to find payroll financing are seeking out alternative lending products like the new Revenued Business Card.
We're working on some pretty cool new pieces of content, including tools that will give you insight into your business finances.
Want to be the first to know when they launch?