There are two types of scenarios that cause a need for a solution for payroll funding. Scenario one is where you have time to look for and review options for payroll financing or working capital to grow your business. Scenario two for funding options is when you have a hiccup in your cash flow and you need payroll funding immediately to meet your payroll deadline.
This article is going to provide the answers to some pertinent everyday financing questions for business owners. What payroll funding companies are available? How does payroll funding work? And are there other reliable alternative financing solutions other than utilizing a payroll funding company.
IRS and State Rules Regarding Payroll
The most important rule that you need to be aware of is that it is illegal not to pay your employees on time.
Not paying employees their earned paycheck will not only land the operator of the business in hot water with the IRS, but it can also result in action being taken by the Department of Labor. The U.S. Department of Labor mandates that an employer must pay covered non-exempt employees the full minimum wage, along with any accrued statutory overtime for a given workweek. Failure to do so is a direct violation of the Fair Labor Standards Act and will result in severe monetary penalties.
Once it becomes obvious that you are not able to meet your payroll obligations from the profits of your business, a swift, decisive, and possibly desperate action must be taken at once. Not paying your employees can result in lawsuits and serious federal and state tax liabilities.
If you cannot meet payroll the business owner, and or controlling parties of the business will be responsible for penalties and fines with regards to payroll taxes due to the IRS that can equate to 50 percent of the total that is owed for the year. Those fees remain with you, personally, for life until the IRS/state fines are paid in their entirety.
Payroll Company Problems
A potential problem can occur between you and your payroll company if payroll is missed. The last thing that your payroll company wants to incur is an audit or problems with the IRS or state government. It’s important that you realize that your payroll company has hundreds of other clients. Payroll companies are watched closely by the IRS and other government agencies because they are expected to conduct themselves in a responsible manner. If you repeatedly miss payroll, you can expect your payroll company to drop you as a client because they want to avoid potential negative exposure.
Informing Your Employees
The unfortunate part of potentially missing payroll is that it is often due to unforeseen circumstances that usually transpire at the last minute. Many small business owners rely upon only a few clients for 80% of their business. Subsequently, when a payment delay occurs, it can cause payroll ramifications. Many small businesses seek funding options only after they have experienced their first missed payroll incident.
Financing Solutions Managing Partner Stephen Halasnik made this statement, “It’s a normal occurrence on a Monday, to receive frantic calls from business owners, needing an instant business line of credit so that they can meet their payroll obligations on Friday.” Generally, after experiencing that first panic instance of potentially missing payroll, as a business owner, and having the arduous task of relaying that information to your employees, most owners tend to make certain that a line of credit, or other payroll financing solutions are in place”.
Having to inform your employees about a missed payroll is an uncomfortable situation. The first time it happens, the business owner will inevitably learn firsthand, just how many of their employees live paycheck to paycheck. In addition, that owner and employee trusting relationship that you’ve worked so hard to develop becomes tainted. There are also accessible, websites, such as Glassdoor, that are available to disgruntled employees, which allows them to openly share their dissatisfaction. This can result in damage to your reputation and cause future hires to be skeptical about joining your company.
In the event that you cannot acquire payroll funding, another option is to speak to your highest-paid employees about accepting less money on payday instead of asking the rank and file. Usually, your highest-paid employees have the most vested interest in the company succeeding.
Financing Solutions Line of Credit
Setting up a Financing Solutions business line of credit is a good option to have in place, even if you are not presently in jeopardy of missing payroll. There are significant benefits of payroll funding when you obtain a line of credit from Financing Solutions for the business owner. There’s no setup cost, no cost if the line is not being used, and it is inexpensive when utilized. The business line of credit is excellent, and will undoubtedly meet your business needs.
The process for obtaining a Financing Solutions line of credit is effortless. The online application can be filled out in 2 minutes or less. An offer letter is emailed out the same day and there is no credit check necessary to receive an offer letter. When the business owner accepts the offer letter and decides to move forward, a few simple documents will be needed such as bank statements, a tax return, and a few other easy to find documents. The great news is that your line of credit can be set up in as little as 72 hours.
In order to qualify for the line of credit, the business or nonprofit, needs to have an average yearly revenue of $400,000. The person signing the contract needs to have a 650 or better credit score. There is no collateral or personal guarantees required.
The Financing Solutions line of credit is excellent for many small businesses like staffing businesses, nonprofits, daycares, auto repair shops, and many other businesses, up to $6 million in yearly revenue. Temporary staffing companies, in particular, are some of Financing Solutions’ premier clients due to the vital problems that can occur if payroll is missed.
Although the credit line can be used for all of your business needs, Financing Solutions is frequently labeled as a payroll financing company because most small businesses make use of the line of credit to meet payroll demands.
Discounting Your Existing Outstanding Invoices
Another method of obtaining funds speedily is to reach out to your clients with outstanding invoices, and ask them if they would be willing to send you immediate funds in exchange for a rather large discount on an invoice(s) they have now.
When you are ready to have that discussion, it is best to have it with the companies CFO, accountant, or their highest level financial personnel. That person will undoubtedly have an excellent mindset and incentive to move forward because they have an understanding of the ramifications that a temporary cash-flow can cause in conjunction with payroll funding.
Accounts Receivable Factoring or Invoice Factoring
Accounts receivable Factoring or Invoice Factoring, are very old forms of business financing. A factoring company will structure an arrangement with your company where they will advance you up to 90% of an unpaid invoice in exchange for their fees. Once ALL of the charges are added up in accordance with the contract arrangement, you can expect to be paying an APR of 18-28% or higher in interest rates.
Obtaining this type of business financing can be cumbersome. Once the contract is signed with the factor, the factoring company then begins the grueling process of deciding which of your clients can participate, based on their creditworthiness and credit quality. You will then send a valid copy of your invoices to the factoring company and the factor will advance you up to 80-90% of the value of the invoice. Your clients will be contacted and will have to agree to send all payments directly to the Factor. Once your client pays their invoice, the factor retains their percentage fee and an agreed-upon amount that is set aside for cash reserves. The remaining balance is sent to you.
Factoring is certainly not a short term, nor quick fix for payroll finance, but in the long run, it can give you some comfort that you have a payroll financing company in place to meet your payroll needs. While it is a common practice for companies in the staffing industry to use staffing factoring, some staffing agencies that have good cash flow, are now inclined to apply for a bank or Financing Solutions line of credit because it is less expensive.
Business owners face some challenges when working with an invoice factoring arrangement. This arrangement is ordinarily a long-term contract, where you will find yourself paying significantly more in overall costs than the 18-28% APR you originally consented to pay. This contract can be difficult to close out and you will often encounter times when you may not need the financing, but yet you will still be locked into the contract.
Bank Loans and Lines of Credit
Commercial or local banks are often misunderstood by business people that haven’t applied for a business loan with them before. Many business owners feel that their business is in good standings and the process of securing a bank loan is simple.
All banks or credit unions require collateral and personal guarantees. Collateral could be equity in your home, stocks, bonds, accounts receivable, or other liquid assets. In the event that you or your business partner(s) have credit scores under 680, it will be extremely difficult for you to get approved.
Banks also review certain ratios in your business like debt to revenue ratios and other business indicators. These ratios make it almost impossible for you if you will be approved.
Filling out a bank application commonly requires a full week or more of your time, due to the fact that the bank asks for both personal and business information. Once the application is submitted, the turnaround time for the approval and set up of the loan is usually 3 or more months. If you have time on your hands, then a bank line of credit or loan is the best way to go because it is the cheapest form of payroll funding.
Merchant Cash Advances
Merchant Cash Advances (MCA) are online lenders that advance you money expeditiously. Your business can pay back the loan in two ways. The MCA company will take a % of your daily credit card machine usage, or through a daily automatic draw from your bank account.
MCA companies are very expensive, often charging as much as 150% APR. One of the biggest mistakes that many desperate business owners make, is thinking that they can pay the cash advance off prior to the end date of the contract.
It is in all probability, best to stay away from MCA companies unless it is your only obtainable option.
Hard Money Lenders
Hard money lenders are used more commonly in real estate transactions, rather than payroll financing. A hard money lender will speedily provide a loan against real estate because the loan is secured against the real property. The interest rate will be considerably lower than what a merchant cash advance company will offer. While it can be done, it is not the norm for hard money lenders to loan money for payroll funding.
Credit Card Cash Advances
Credit card’s cash advances were previously the go-to source for businesses when a quick loan was needed. However, the amount approved for cash advance purposes on a credit card is often very small.
In the past, it wasn’t uncommon for a business to apply for and use several credit cards at one time, with the hope of being able to resolve their financial crisis quickly and quietly. Unfortunately for business owners, most credit card companies have caught onto this practice. Now when you apply for a credit card, it is immediately reported to all of the credit rating agencies and credit card companies are able to see that you have applied for credit with multiple companies.
Keep in mind that all credit cards used by small businesses, are under a personal guarantee, and can ultimately affect your credit score.
Loans from Family and Friends
In an emergency situation, many business owners often seek to secure loans from family and friends to fund payroll but that can quickly become complicated. Often, it depends on the requested amount you are looking to receive. A loan of only a few thousand dollars can appear to be a simple request, but if it is in the range of $50,000, you might find that is an amount your family/friends don’t readily have available.
By borrowing from family/friends, it often opens the door for them to scrutinize your business and personal life. If people are not business owners themselves, they might have a difficult time comprehending the need for such a vast amount of money. This can lead to them jumping to the conclusion that your business is in trouble when the reality might just be that you have a cash flow or growth issue.
If the event that you do choose to borrow from family/friends, make sure the transaction is in writing, and signed by all parties involved. Make sure your contract includes a payment term sheet along with interest rates that are equivalent to the market rate. When your family/friends see that you are responsible for ensuring that this is documented as a legitimate transaction, their perspective will change, and they will perceive you to be an honest business owner that runs a solid business.
Your payroll funding transaction is considered to be successfully resolved when you have paid your family/friend back. Your next step should be to apply for a line of credit so that you will never be placed in that situation again.
Future Cash Flow for Better Payroll Funding
Change Your Payroll Processing Cycle
If your payroll processing cycle is payroll paid weekly, then consider switching to twice a month or if possible, once a month. If your business employs commissioned salespeople, pay them their commissions when you get paid, or implement a standard commission payroll processing period of 45 days from when the invoice is first generated. You can explain to your salespeople that the change is because it coincides with when you get paid.
Lowering Your Business Expenses
Taking a closer look at your monthly business expenses will allow you to see if additional reductions can be made to give yourself more breathing room to fund payroll. It is also a good idea to talk to your trade association, competitors, or accountant to see if your business expenses are in line with your industry. Business expenses have a way of inching up on expenses, so it is always a good idea to review all your business expenses monthly so you have the pulse of your business.
Reduction in Hours
At certain times of the year, or when your business cash flow is low, you can ask your employees to take reduced or unpaid days off. You might find yourself astonished at their reaction to having Fridays off during the summer, or at other times of the year.
How to Address Account Receivable Moving Forward
Most business owners tend to delegate AR collections to someone else. That person often may not have the skills or motivation to accelerate the AR turnaround time. Once you, as a business owner, understand the process, and get involved, you will come up with some effective ideas that are very simple to implement.
Effective ideas to improve AR turnaround time:
- Ensure the bill is going to the right person in accounts payable
- Follow up once on all invoices go out to make sure it is received
- Have a process in place to follow up on payments at set times
- Have the names/contact info of your clients AP personnel and their manager
- Address delayed payments in an expeditious manner
- Monitor your AR weekly
- Set aside a time to speak with clients that routinely pay late
Fire or Charge Late Paying Clients
Up until this point, you might not have ever noticed that one of your clients always pays their invoices late. If after addressing this issue with them, and no change occurs in getting your bills paid on time, then consider either increasing what you charge or terminating your working relationship with that client. If you are inclined to take the route of utilizing the services of a payroll funding company that will inevitably cost you extra, then it is time to look for other clients that will render payment in a timely manner.
Change Your Business Model
If you find that you need to utilize the services of a payroll funding company, you might first take a look at your business model to see if your product pricing is competitive. A lot of small businesses just undercharge and are often afraid to increase their prices out of fear of losing clients. However, the number one rule in business is to never compete on price. Ask yourself these questions when you are reviewing your business model.
- Are you charging enough?
- Are you delivering more than your competition?
- Do you have solid client relationships that won’t debate a price increase?
- Can you increase pricing for new clients?
- When was the last time that your business had a price increase?
- Are you losing the price war against your competition?
At the end of the day, remember that you are the leader of your company. if you are unable to make payroll, your employees need to know that you are exercising every option to ensure that they will be paid on time. Refrain from driving to your office in your Porsche, don’t go on that 14-day European vacation, and don’t be seen wearing a brand new piece of expensive jewelry when you have just missed payroll. If your employees believe that you are doing your best to get them paid on time, they will continue to trust you.