Payroll funding refers to financing used to cover your payroll expenses when you can’t make payments with available cash. It may be needed to fund an upcoming busy season, when you grow too fast, or if you have slow-paying customers. Funding speed is the most important aspect of choosing the right payroll financing option to meet your needs.
Payroll Funding Options for Small Businesses
There are no loans that are classified specifically as payroll financing. Instead, payroll funding comes in the form of either short-term loans or lines of credit offered by alternative lenders that can fund within a few days. Long-term loans, such as Small Business Administration (SBA) loans, won’t work for payroll financing because they take 30 to 90 days or longer to fund.
The best payroll funding options include small business lines of credit and short-term business loans.
Small Business Lines of Credit
A business line of credit (LOC) gives you a maximum credit line that you can draw against as many times as you want until you hit your credit limit. For example, if your maximum borrowing limit was $10,000, then you could borrow $3,000, $5,000, and $2,000 at different periods of time. You can make additional draws as long as you repay the amount you use.
Terms for a business line of credit vary by lender. It’s common to see rates ranging from 10% to 40% and repayment terms from a few months up to five years. Keep in mind that some lenders treat each draw like its own loan with fixed monthly payments, which could cost you more money during repayment.
A business line of credit for payroll financing can come from an online or traditional lender. An online lender will provide faster funding than a traditional bank, which can often take up to a few weeks to offer funding. A business line of credit best serves business owners seeking to solve an ongoing payroll issue.
Short-term Business Loans
A short-term business loan is a lump sum loan you repay within one to three years. The average annual percentage rate (APR) ranges from 30% to 50%, and loan payments are made weekly or monthly. With an online lender, you can get short-term loan financing as soon as one day.
Short-term business loans are easier to qualify for and can fund faster than a line of credit. You can also borrow more money immediately than you could with a line of credit. That makes a short-term loan ideal for a small business needing to make payroll within a week or if you don’t have an ongoing payroll problem that you’ll repeatedly need financing for.
For example, a business owner who has a cash flow shortage at the same time every month will find a line of credit to be a better fit because there is no need to reapply every time you need funding. However, a business owner needing to bring on seasonal employees to prepare for their busy season will find the larger, one-time sum of a short-term loan the better choice.
Ways to Avoid General Payroll Issues
If you’re running into a payroll shortfall consistently, you may need to do an audit of your entire payroll and hiring processes. There are many ways to identify problems in your business that revolve around payroll, which you can do without the need for additional financing. While payroll funding will help you fill your short-term needs, this audit can improve your long-term sustainability.
Ways to audit your payroll and increase cash flow include run payroll yourself, use physical checks, and delay paying other expenses.
Run Payroll Yourself
If you’re running into payroll problems regularly, finding a solution to the problem can be easier if you start by working backward. The first thing you should ask yourself is when you need the payroll funds available in your account. The answer might not be as obvious as you think.
For example, many small businesses use the services of a payroll company. While a payroll company can relieve you of many administrative burdens, it can also mean you need funds available for payroll three to four days before the actual payday.
If you’re not using a payroll company, you won’t need the funds available until the day before payday. You won’t have to worry about the payroll company’s processing time, which allows you a couple of days of float in your cash flow. So, depending on the size and complexity of your payroll needs, you may benefit from completing the administrative work yourself to gain a little more flexibility.
Use Physical Checks
The primary reasons small businesses pay their employees via direct deposit are the convenience for employees and reduced administrative tasks for the small business owner. However, if you’re regularly facing uncertainty about being able to make payroll on time, there may be some benefits to using physical checks.
Shifting to a physical check system can create some wiggle room for you as an employer. While you can’t rely on it 100%, the time it takes for the bank to clear the check may create another day before the funds are drawn from your account.
Some employees may not deposit your check right away. Keep in mind, with the ability to deposit checks at an ATM or via their smartphone, the amount of time created by issuing your employees a paper check is much less than it used to be.
Delay Paying Other Expenses
Being late on your payroll will create significant problems between you and your employees. Untimely payroll problems can create inconveniences for employees that you may be able to rectify, but they can also harm employee trust and satisfaction, which can be much more difficult to resolve.
Consider what other bills you might put off before missing payroll. While your vendors, suppliers, and utility providers won’t be happy to receive a payment late, it’s also less likely to create lasting damage to your relationship if it’s not a common occurrence.
Another expense to consider is the owner’s salary. If you have to send a paycheck out late, yours is the one that creates the fewest problems. Not only that, but you can also customize how you pay yourself if irregular revenue makes it challenging to meet payroll during certain times of the month or year.
Common Payroll Problems and Solutions
Whether you meet your payroll financing needs with a short-term small business loan or with a small business line of credit, borrowing to meet payroll should not become a regular occurrence. Payroll funding can solve many problems, but the need for it can be mitigated by planning.
Common payroll problems you can solve before getting payroll funding include hiring need outpaces revenue growth, hiring seasonal or temporary workers, overstaffing, and miscalculating payroll taxes.
Hiring Need Outpaces Revenue Growth
When your business does well, you can feel pressure to maintain growth by hiring more staff. Often, a business owner will put the cart before the horse and expand their payroll or other expenses faster than their revenue can maintain. Even if you’re expecting increases in revenue that justify the new positions, your revenue may take a while to materialize.
If you want to increase your headcount faster than you earn revenue, you need to have the cash available to float the increased payroll expenses. If you do not have the cash savings to cover the increase in payroll, you’ll want to either hold off on hiring more employees or make sure you have other financing available to cover payroll expenses. Poor financial planning can put your growing business at risk in a detrimental and unsustainable way.
Hiring Seasonal or Temporary Workers
If you do most of your business during a particular season, your payroll expenses likely increase during that time to keep up with demand. This is common for landscapers, restaurants in resort towns, retailers, and businesses in college and university communities. Businesses with seasonality are cyclical and predictable.
Because you must hire seasonal employees before the busy season starts, prepare in advance by having funds available. You’ll either need to set money aside from the last season to afford the increases in payroll expenses, or you must get an affordable financing option for your business.
Small business owners have many jobs to juggle at once. This can leave you with little time to think about operations and processes. Business owners can fall into the bad habit of throwing another body at problems or tasks as they arise. If business slows, these added positions can create a huge payroll funding problem if you don’t take the time to calculate your payroll expenses.
Payroll funding can help if you need employees but can’t afford them all the time. It can help you overcome the bumps of paying employee salaries when your business is slower to maintain the number of employees you need during the busy periods. However, another solution is not to hire these additional employees and get by with fewer workers during your busy time.
Miscalculating Payroll Taxes
If you make a mistake calculating your payroll taxes, the IRS will send you a notice that you have taxes due. This notice will come after you have spent the money that you need to pay these taxes. There are ways to limit a large IRS bill and the impact it could have on your ability to make payroll.
While payroll funding, or working with the IRS can help with this problem, the better scenario is to eliminate potential risk by having your payroll team work with your accounting team to verify all payroll payments. Too many accounting teams pay the tax numbers that the payroll processors quote them instead of auditing payroll to make sure calculations are correct.
Pros and Cons of Payroll Financing
Payroll financing can help your business quickly fill a payroll gap with no need to wait weeks for a traditional bank to get you funding. You can also use the funding repeatedly if you get a line of credit and leverage it to fuel growth if your business is experiencing increased demand. However, financing your payroll can be expensive, and it doesn’t resolve any underlying issues that can cause payroll funding.
Pros of Payroll Financing
- Ability to meet payroll needs quickly: Payroll shortfalls typically occur with little warning. Getting access to financing in a few days, rather than a few weeks, can keep your business operational and ensure that you can keep employees.
- Opportunity to access funds repeatedly: Some payroll shortages occur regularly, whether you are financing the payroll of new employees, or growing your workforce seasonally. Getting a line of credit that you can draw upon whenever you need to fund payroll is much more convenient than other financing options.
- Ability to fuel growth: If your business is growing and requires more employees, you may be in a position where revenues temporarily fall below payroll expenses. Using payroll financing in this situation can allow you to continue to fuel the growth of your company, rather than slowing down and missing opportunities.
Cons of Payroll Financing
- Potentially high overall cost: The higher APR of short-term payroll financing options can be difficult for some businesses to afford. Although you are likely to pay less in dollar terms for the funding overall, financing your payroll might compound an already weakened cash flow position.
- Possibly not addressing an underlying payroll issue: Although many payroll issues occur without a major problem, some payroll issues have larger underlying causes. Financing can relieve the issue temporarily and give you a better vantage point but failing to address the primary problem all but ensures future payroll shortfalls.
The best solution to solving your payroll problems is to get a short-term loan or line of credit from an alternative lender. A short-term loan is best if you view your payroll shortage as a one-time thing. If you have consistent problems meeting payroll, then a line of credit is the right choice.