One of the most unsettling feelings you can have as a business owner is to find yourself low on funds when it’s time to run payroll. While it’s very stressful, the first thing you should know is that this happens. Second, there are payroll financing options created just for small businesses who’ve gone through the exact same thing.
New businesses often struggle with cash flow. An established business could suddenly be hit with a large, unexpected expense or for some businesses it’s because your outstanding invoices haven’t come in as quickly as needed. In fact, this post was inspired by conversations with several ForwardAI customers.
If not having enough money to make payroll was really rare, these payroll financing options would never have been created. (Note: While it’s good to know you have options, it’s even better to not have to use them.)
Table of Contents
- 1 What you should do once you realize you can’t make payroll
- 2 What you need to know about payroll funding for small business
- 3 Using short-term loans to fund payroll
- 4 Using medium-term loans to cover the cost of payroll
- 5 Using a business line of credit to finance payroll
- 6 Using invoice factoring to cover payroll
- 7 Do your homework researching payroll financing options
- 8 How to avoid needing payroll financing in the first place
- 9 One final tip — always pay your payroll taxes
- 10 An ounce of prevention is worth a pound of cure — but’s also good to be prepared
What you should do once you realize you can’t make payroll
To start, you should figure out how much time you have before you need the money for your payroll. This will help you determine which payroll funding option is the best for your business. Using free expense management software can help you take care of that.
Then, you should also communicate with your staff and let them know what’s happening and that you’re looking for a solution. Even if it’s only one day before payday.
If you’re worried about causing panic by telling your staff that you have a cash flow shortage, think of how much worse it will be if you “surprise” them on payday. Consider that, in the United States alone, 71% of workers said it would be hard to pay the bills if their checks were even a little late.
If things get down to the wire and you’re using a payroll provider, you should also give them a call to let them know what’s happening. If you’re making an honest effort to solve the problem, you’re less likely to get listed as a credit risk for insufficient funds. Depending on your provider, they might also be able to offer suggestions. Again, we emphasize, this happens to a lot of small businesses.
What you need to know about payroll funding for small business
Because payroll financing requires a quick turnaround, the best options are short- to medium-term loans, a business line of credit or invoice factoring. Sometimes you may hear one or all of these options classified as payroll loans. All are conveniently offered by online lenders.
If you’re wondering why a traditional small business loan is usually not your best choice when you’re looking for payroll financing, it’s because of the lengthy application and approval process that’s required.
Using short-term loans to fund payroll
A short-term payroll loan will help you finance your payroll within two to three business days or sometimes as little as one business day. If you choose this option, plan to pay the loan back within 12 months and expect to have a higher interest rate.
Using medium-term loans to cover the cost of payroll
If you have up to five business days (a week) before you need payroll financing, you can look into a medium-term loan. With a medium-term payroll loan, you’ll have a longer application and approval process. However, as a result, you’ll have up to five years to pay the amount back. Your interest rates will also be a little lower than with a short-term payroll loan.
Using a business line of credit to finance payroll
If you think there’s a good chance you might have to use payroll financing more than once in the near future, you might want to consider a business line of credit. More of a long-term solution, a business line of credit provides you with a set amount of money that you can access as need. You also only pay interest on the money you take out.
While business lines of credits are available through traditional banks, they’re much more time-consuming and harder to qualify for than if you apply for one by going through an online lender. Depending on the online lender, you may also be approved in as little as one business day.
Using invoice factoring to cover payroll
If you’re a business-to-business company, you may also be able to sell one of your unpaid invoices in order to finance payroll. This is called invoice factoring. What a purchaser (factor) will do is offer to buy your invoice at a percentage of its value. The factor then gives you the money and collects their funds when the invoice is paid by the customer.
Although the invoice faction is a well-established funding option, there are several variations on this model. When you search for a company that offers invoice factoring, make sure you understand how it works and what the terms will be.
As the main variable in qualifying for invoice factoring is the quality of your invoice, invoice factoring is also a good option for new business-to-business companies who may not have an established credit history.
Do your homework researching payroll financing options
Even if you’re in a hurry, you want to research your payroll financing options, comparing:
- Approval time — how long it takes to get approved.
- Time to receive funds — how long it takes to get the money after approval.
- Available amounts — how much you can get.
- Payback period — how long you have to pay the money back.
- APR — annual percentage rate (interest rate).
You’ll also want to find out what financial and business information you’ll need to provide in order to qualify, such as a credit history, annual revenue and how long you’ve been in business.
How to avoid needing payroll financing in the first place
Again, no one ever intentionally plans to have a gap in their cash flow. In business as in life, we all learn as we go. This is why learning how to read and understand your business financials is so vitally important.
Small business owners come from a range of backgrounds, including varying levels of financial knowledge. But, if you know that accounting isn’t your strength, find a trusted accountant and bookkeeper to help you manage your books. With cloud-based accounting tools, like ForwardAI, this process is even easier than ever before.
Even if reading financial statements doesn’t come naturally, every bit of knowledge that you give yourself makes a world of difference. By regularly reviewing how the money flows in and out of your business, you’ll get a better understanding of the ebbs and flows unique to your business.
For instance, if you run a seasonal business and through monitoring your financials, you know that March is always a slow month, you can then plan ahead by setting funds aside from peak periods, adjusting inventory and reducing shifts for hourly workers.
One final tip — always pay your payroll taxes
Whenever you use a payroll financing to solve a shortage of funds, make sure you also pay your payroll taxes. Payroll taxes are the sums that employers take out of employee paychecks, such as income tax and various social programs, depending on the country.
As payroll taxes are taxes, you’ll only be adding to your woes if you fall behind on your payments. The tax authorities in charge are not lenders and interest on late payments compounds quickly.
If you’re already taking on interest from a loan, you don’t want to make things worse by falling out of grace with the tax authorities. When you have to use payroll financing, borrow enough money to cover every aspect of your payroll. That way you only have to pay interest to one entity instead of several.
An ounce of prevention is worth a pound of cure — but’s also good to be prepared
While everyone wants to avoid mistakes or cash flow shortages, they happen. No matter how rigorous you’ve been with your financials. Knowing that there are payroll financing options, like short- and medium-term loans, a business line of credit or invoice factoring, is the first step in being prepared — should the worst ever happen.
If you’re startup or micro-business looking for free online accounting software, check out ForwardAI.
This article is intended to be informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.
For more small business advice, see some of our top posts: