How Payroll Funding Works

A lot of times, payroll funding is referred to as invoice factoring (and vice versa), although the latter is a broader term than the former. What exactly is payroll funding, and how does it work?

You may have come across such a term as payroll funding when you were working on starting your company. In fact, we have a feeling that you definitely did hear of it back then because payroll funding companies target owners of small and growing businesses like yourself.

A lot of times, payroll funding is referred to as invoice factoring (and vice versa), although the latter is a broader term than the former. What exactly is payroll funding, and how does it work?

Why You May Need Payroll Funding

As we always like to say, payroll is one of your most important and sensitive functions as a business owner and employer. It is a major responsibility, and failing at it can lead to serious consequences for your business. The smooth day-to-day functioning of your company largely relies on your ability to pay your employees on time.

However, in many industries, making payroll can be challenging for owners of small and growing businesses. This problem is due to a wide range of situations related to cash flow. It can be an internal issue, but most of the time, it is because your clients pay you on a certain schedule that may not always coincide with your payroll.

You may also be in an industry in which most of the sales are seasonal. In cases like this, you may not have enough cash on hand to cover payroll during off-peak season. Your team may be rapidly growing, and your reserves are having a hard time catching up.

How Does Payroll Funding Work?

In a nutshell, payroll funding means having a funding company cover your payroll with collateral. The collateral is your accounts receivable, which the payroll funding company buys in two installments.

Depending on your industry, the first installment may cover between 80% and 95% of the value of your invoice. That is called the advance, and it is processed in many cases as quickly as one or two business days. The payroll funding company deposits the advance in your bank account.

When your client pays your invoice in full, the payroll funding company rebates the balance, minus a preset financing fee.

What Is the Catch?

Rates can vary depending on the size of your business, your industry, the amount you need, and the credit quality of your customers. Generally, though, Canadian payroll funding entities charge anywhere between 1.5% and 3.5% per 30 days.

Pros and Cons

Look at the good and the bad of payroll funding before making your decision. The great thing about it is that it covers your payroll on time, which is good news to your employees (and in turn, to your business), and it improves cash flow, allowing you to offer lax payment terms to your clients.

Payroll funding is also easier to obtain than business loans and other traditional funding programs. Moreover, the larger your business grows, the more credit line you get. However, payroll funding is more expensive than other alternatives.

Conclusion

Payroll funding is a very attractive financing option for your business, especially if you are a small company and/or are in a seasonal industry. It ensures that your employees are always paid on time and allows you to offer relaxed payment terms to your clients. However, as is the case with tempting financing options, payroll funding can be expensive.

Therefore, think about it, and speak to an expert once you arrive at a decision.

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