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Making payroll on time is essential for any business. However, If a company’s clients have long net terms, for example, the company may struggle to maintain positive cash flow even if it is profitable. A solution to this is payroll factoring.
Payroll factoring allows you to sell outstanding invoices at a discount to a third-party company, known as a factoring company or, simply, a factor. The proceeds can then be used to pay employees.
The factoring company assumes the responsibility of collecting payments from your customers – either on a permanent or temporary basis – and keeps a small percentage of the total invoice amount as their fee. A factoring company can buy just a few of your invoices, known as spot factoring, or all of them, known as whole ledger or full-turn factoring. To learn about the cost of factoring, please visit our Small Business Factoring page.
Other types of payroll finance are working capital loans, credit cards or merchant cash advance (MCA). Business Factors can help you determine the best payroll funding arrangement.
A company can factor invoices in four simple steps:
- The business provides a factor with a copy of the invoice that was sent to the client
- The factor verifies the invoice and runs a credit check on that client
- The factor advances a portion of the outstanding amount
- Once the invoice is paid, the business gets the remainder minus the discount rate and any additional fees
Here are some advantages of payroll factoring:
- Gives businesses working capital in 24 to 48 hours without taking out a loan or opening a line of credit.
- Eliminates the wait time associated with collecting payment from customers in exchange for a small fee
- Factoring companies can take over accounts receivable management for the invoices they’ve factored, eliminating or reducing the need for back office staff.
- With a positive cash flow, businesses can use the money to not only pay employees on time but also grow the enterprise, look for new clients, purchase new assets or offer more competitive salaries to their employees.
Two types of payroll factoring are available depending on the needs of your business:
- No-service factoring. Here, the factor only purchases your invoice(s). Your company retains the responsibility of performing subsequent tasks, such as processing the cash, filing it, directing it toward employee salaries, etc. This option is good for businesses that need a payroll funding solution but not comprehensive business support.
- Full-service payroll factoring. This option gives the factoring company additional responsibilities such as processing paychecks, filing tax returns, and other business tasks in addition to turning unpaid invoices into cash. Here, your business processes are outsourced to the factoring company. Business Factors offers full-service factoring saving – including complimentary credit checks on your clients – saving your business time and money.
Let’s take a look at a case involving a telecom company that successfully used payroll factoring.
The company urgently needed capital to pay its employees. It was experiencing cash flow problems because its main client – the government – was behind on paying the company for the work already completed.
After turning to payroll factoring, the company was able to monetize a $100,000 invoice and use the funds to meet payroll and fund other working capital expenses. The move allowed the company to keep its best talent and avoid labor complaints. Here is the exact arrangement used by this client. Please note that the cost of factoring varies across the industry. To get a quote, please contact us.
- Invoice amount: $100,000
- Advance rate: 85%
- Reserve: $15,000
- Discount rate: 3% per month until the invoice is collected; fee capped at the reserve amount
- Type of arrangement: non-recourse
In this case, the invoice was collected in two months meaning that the client paid $6,000 to monetize it in 48 hours. Once the payment was made, the remainder of the reserve ($9,000) was refunded to the client. The arrangement was non-recourse meaning that there would be no chargeback to the telecom company if the invoice would not have been paid.
Payroll factoring can be an attractive option for companies that need cash to pay employees or fund business operations. By selling invoices to a factoring company at a discount, businesses can immediately get cash without incurring debt.
While business loans may take a considerable amount of time to be approved, payroll factoring can provide funds in as little as 24 to 48 hours. It allows a business to outsource their entire accounts receivable department through full-service factoring so that the third-party assumes the responsibility of collecting payments from customers. Money-only payroll factoring which only provides funds without any additional services.