How to figure out if payroll factoring is a good choice for your business.
Intro To Payroll Factoring
By law, all businesses must pay employees in a timely manner. After all, as a business owner, you are responsible for the livelihoods of other people. However, once in a while in tough financial situations, making payroll can be a challenge. If you have outstanding invoices with net terms between 15 to 90 days, there’s a chance that your customers will pay you only after a payroll cycle or two. This create a huge gap in your cash flow, putting your employees at risk for not getting paid. Luckily, there is a type of financing called payroll invoice factoring that solves this common issue.
What is payroll invoice factoring?
Payroll invoice factoring is a solution that helps generate earlier cash flow for businesses with outstanding invoices with long net terms, usually between 30 to 120 days. It is not a loan, but rather a transfer of invoice from your business to a third-party company called a factoring company. Through payroll invoice financing, the company will be able to supply you with an advancement in exchange for your invoices. Thanks to this type of financing, business can continue working hard to run their businesses without worrying about losing their loyal employees.
Who can benefit from payroll invoice factoring?
Any business that employs employees will benefit from payroll invoice factoring. Regardless of whether they are full-time or part-time employees, employees rely on their paycheck to stay motivated to work. Many business owners would agree that the key ingredients to running a successful business is to take care of their employees.
Problems & Solutions Faced by Payroll Invoice Factoring
Making sure that you can make payroll each week has more underlying benefits. This includes:
- Protecting Personal Savings - Especially for startups, when business owners find it difficult to make payroll, they usually take a pay cut or start digging into their personal savings. If they do not have enough savings or have already made huge cut into their own salaries, they can start drawing funds from family, friends, or even retirement accounts. While making sacrifices and being resourceful is admirable for any business owner, this method of making payroll can put a business owner’s own financial health at risk. With invoice factoring, your personal savings is safe and will stay untouched, so that you can focus on running the business instead of worry about your own personal issues.
- Avoid Additional Debt- Many business owners also turn to taking on a traditional business loans to make payroll. However, they must pay loans back and will rack up much higher interest rates than the fees charged by invoice factoring. In addition, especially for young businesses, some businesses may not even qualify for a loan and may take on the risk of putting their house as collateral or even higher interest rates. With invoice factoring, there is no loan - it is the sale of invoices, which mean the fee is small and the approval process can be much faster.
- Prevent Layoffs - Finding great talent to work for you is not easy, especially when these individuals gained so much valuable experience that they did working for you. Taking on invoice factoring ensures that you can keep your talent and prevent laying them off. As you grow, your most experienced employees will be the ones who will really be the backbone to your success. Your ability to secure their jobs and pay them in a timely manner is your commitment to them in exchange for their commitment to you.
- Avoid lawsuits and penalties - If you fail to pay your employees on time or at all, you are at risk of being hit with federal and state tax liabilities, IRS penalties, and lawsuits. These types of issues are time consuming to deal with and will only add additional costs as you may need to hire a lawyer and will be taking time out of your busy day to resolve them.
How does Payroll Invoice Factoring Work
Business interested in receiving payroll invoice financing must work with a factoring company to begin this process. Although there are many factoring companies out there that provide payroll invoice factoring, each one works more or less along the same line:
1 - Research and Find a Factor
First, as soon as you have sent out your invoices with a due date between 30 to 120 days, you can begin searching for a factoring company that is best fit for your business and sell your invoices to them.
Once you have completed your research and picked a factoring company, the factoring company will check your business as well as the past and present invoices you are factoring. They may also ask for information as well as credit checks on your clients.
After passing this review, the factoring company will give you an agreement to review and sign. It is helpful for you to bring in a lawyer to review this document as this agreement will include details about all fees, the payment plan and conditions, and the initial maximum fund amount you can receive, which would be the maximum factored amount outstanding at any time.
2 - Signing the Factor Agreement
After you sign the agreement, the factoring process will begin. First, the factor will give you an advancement either by bank wire or check that you can use called the advance rate, which is usually 80% - 90% of the invoice’s value. You can start using this advancement as soon as 3 business days.
Also, since factoring usually involves transferring the responsibility of bill collections away from the factoring company, the factoring company will also contact the clients with information on how to send payments. Your clients need to be informed of your factoring agreement in order to understand why they will be paying a different company.
3 - Your Clients Pays the Invoice
After the client has paid for the invoice on time, the factoring company will send any remaining balances, known as the reverse amount, to you. As compensation for this invoice factoring services, the factoring company will also deduct a service fee, or rebate, from the remittance. Your agreement outlines this fee ahead of time.
How does Invoice Receivables Financing Work?
As you are considering invoice factoring, you may also be interested in a similar financing plan called payroll invoice financing, or invoice receivables financing. Like invoice factoring, invoice financing also solves the issue of limited or low cash flow issues by providing advancements on invoices. Also, payroll invoice factoring also requires a third party company to coordinate the financing.
What separates invoice factoring from invoice financing are:
- Invoice financing companies have many tools to determine your customers’ reliability without a credit check, so credit checks aren’t required
- You have complete responsibility for receiving invoice payments from your clients and responsible for paying your advancement plus fee back to the third-party
- You get to have the complete total amount of the advancement as soon upon approval, rather than a portion
- The application process for financing take less time than for invoice factoring and be as quick as a few hours or few days
- Invoice financing has adopted the latest technology where all transactions, including withdrawals and payments are done electronically
- Invoice financing is a lot more transparent with fees, so you don’t need to worry about hidden fees, clauses, or unforeseen costs