Advantages and Disadvantages of Payroll Financing

Payroll financing is an effective way to provide funding for companies that need working capital to pay employees. Companies that have large payrolls will often times experience problems with their cash flow because of slow-paying clients. When this happens, the company will pay employees using its own cash reserves. If the company is growing quickly, cash reserves can be depleted, preventing growth.

Traditionally, payroll financing is used by consulting and staffing companies. However, this solution can be used by companies in most industries, as long as they need funds to meet payroll and sell products/services to commercial clients. It is also available to startups and small businesses as long as they meet the funding requirements.

Today we discuss the pros and cons of payroll financing.

Advantages of Payroll Financing

A payroll financing solution offers numerous advantages for your company, especially if the company is growing fast. The following are the most important advantages:

Enables you to grow your business

Commercial clients pay their invoices slowly, in 30 to 60 days. The delay can hurt your cash flow and prevent you from adding staff to handle business growth. Payroll financing enables you to add the staff you need to fulfill new client orders and grow.

Some types of payroll financing are easy to get

Factoring, a type of payroll financing, is easy to get than other types of financing. Usually, the most important requirement to qualify for factoring is to work with creditworthy commercial clients. Factoring companies do not require the traditional underwriting that banks go through. This advantage is important for small and growing businesses that cannot meet bank lending requirements.

Lines are flexible

Lines offered through a factoring solution are flexible and can grow with your business. This key advantage can be helpful while your business gets new orders and needs additional staff. The line grows as long as your clients have good commercial credit, and your company continues to meet the funding requirements.

Can be transition to conventional financing

It can be used as a transition to conventional financing solutions such as a business line of credit. Companies often use factoring for a couple years and move on to other types of financing once they have built a track record.

Lines of credit are the most cost-effective types of financing, but they do have more restrictions. They are a good option for businesses that are maturing.

Allows you to offer net-30 terms

Most clients pay in 30 to 60 days. However, business have to pay employees weekly or biweekly. Unless you have a cash reserve, this model does not sustain growth. Your reserve runs out eventually and this is hard for companies in the staffing and consulting industries.

Payroll financing helps you bridge the gap between rendering a service and getting paid. This solution allows you to offer competitive terms to your clients and provides a financial platform for adding clients.

Can be obtained fast

Payroll funding solutions can be obtained quickly. It can be obtained in a week or so. The time it takes to deploy a line varies based on clients’ individual circumstances.

Factoring does not incur debt

Factoring transactions are structured as the sale of your receivables, rather than as a loan against them. It can be important for larger companies who may look for conventional funding later on.

Disadvantages of Payroll Financing

The following are the two most important disadvantages of payroll financing.

Costs more than lines of credit

Payroll financing usually costs more than conventional bank financing. Payroll financing is best used by companies that have higher margins or companies that get paid quickly.

Factoring costs are determined through volume and the speed at which your clients pay. It works best if your company has a gross margin of at least 15%, however, higher margins are better. If your clients pay invoices slowly consider financing only those invoices that higher gross margins.

Lack of transparency to clients

Factoring lines are not always transparent to your clients. However, factoring companies always work with you to determine the right way to deploy the solution and reduce client issues.

The Bottom Line

Payroll financing can be an ideal solution for companies that are growing fast and need funding to cover staffing costs. This solution works best if your clients have good credit, they pay on 30 to 60 day terms, and have margins of at least 15%.