23 Feb Payroll Factoring Vs Payroll Funding
It’s not uncommon for a business to be short on funds. As the time for payroll draws near, many a business owner may be scrambling to figure out how to run payroll on time and meet his or her financial demands. There are two primary methods available to benefit business owners who find themselves in such scenarios. The first is payroll factoring and the second is payroll funding.
Oftentimes, a payroll factoring company will advertise its services as payroll funding. However, it is important to know that payroll factoring and payroll funding are in fact very different. Before taking out a loan, be sure to ask – is it truly payroll funding? Payroll funding will not be factoring accounts receivables, whereas factoring will do just that. There are alternatives to factoring, so don’t immediately assume that is your only recourse if you are short on funds.
What Is Payroll Factoring?
In order to understand the differences between payroll funding and payroll factoring, let’s begin to break down what payroll factoring actually means. Payroll factoring, also known as staffing factoring, is the funding for a loan backed by a payroll invoice. How does that come about?
When a staffing agency leases personnel to a business, the employee’s employment agreement is with the staffing agency, who will in turn bill the client the agreed upon bill rate. The staffing agency pays the employee’s salary and then bills the client with a typical invoice. As is the case with most invoices, the client then has 30 to 90 days to pay. This is beneficial to employers since it gives them additional time to pay, however it could put a lot of financial strain on the staffing agency because they have to pay an employee’s salary they have not yet gotten the funds for.
Due to this lag, factoring for staffing companies is fairly common. The factoring process allows them to sell their payroll invoices to get immediate funds, and they agree to pay a percentage for that.
Payroll Factoring Vs Invoice Factoring
While the terms are often used interchangeably, payroll factoring and invoice factoring are not exactly the same thing. Invoice factoring or AR factoring essentially means selling your accounts receivable invoices to a third party at a discounted rate in exchange for immediate cash flow.
Whereas invoice factoring is a loan that is backed by any invoice, and is used by businesses in many industries, including wholesalers and manufacturers etc. Payroll factoring is used specifically by staffing companies to fund their payroll invoices.
What’s important to remember is that the payroll or invoice factoring company essentially gains total control over your accounts receivable. They will collect funds from open invoices directly from your customers, thereby giving them full authority over customer interaction and payment terms. As a business owner, relinquishing so much control of your entire AR department just because you are short on funds for payroll, is not always ideal. So, before you decide on a business factoring loan, consider payroll funding (not payroll factoring) as an alternative option.
The Difference Between Payroll Funding and Factoring
There are many crucial differences between payroll funding and factoring. It is important to understand how they differ so that you, the business owner, can make the best decision for your business. Below is a breakdown of the comparison of the payroll financing methods.
- Getting approved for payroll funding is based solely on your business’s credibility. Factoring approval is based on the credibility of the open invoices. This means that you can have solid revenue and a good business history, but if your clients don’t have good credit histories, there is a good chance your factoring loan would be denied. However, your payroll funding loan would be approved without difficulty.
- Payroll funding will make sure you have enough funds to cover payroll, whereas factoring does not guarantee that. With factoring payroll or factoring invoices, the loan is based off your open invoices. That may be more than you need, causing you to pay unnecessary interest and fees on too large of a loan, thereby increasing your debt. Alternatively, it may not even be enough to help you cover payroll and then you haven’t even solved your cash flow problem.
- Payroll funding works in conjunction with your payroll company, thereby making sure that the funds are in your account in time for payroll. Factoring companies are usually not committed to that.
- With payroll funding, you have the flexibility to pay the loan back early and therefore only pay for the exact amount of time that you had the money. When factoring, you’ll either pay the fixed rate per invoice factored or you’ll pay for as long as it takes the factoring company to collect on the invoice, generally between 30 to 90 days. You won’t have the option to pay back the loan earlier, even if you only needed the money for a week or two. It is for this reason that payroll funding loans are considered short-term loans, with a max time frame of four weeks, while factoring loans are usually more long term.
On the flip side, it is important to mention that payroll funding is only an option if you employ at least three W2 employees and have been in business for at least two years. If you are a new business owner and/or employ contractors who work on a 1099, a factoring loan might be your best option. Additionally, in order to qualify for payroll funding, you need to be able to show a positive cash flow over a three-month period.
In conclusion, if your business is temporarily short on funds and you do not want to run payroll late and deal with the consequences that come along with that, getting a loan can be your best bet. Just remember that there are invoice factoring alternatives, i.e. payroll funding, which may serve you better. Even more importantly, always make sure to pay attention to terminology. As mentioned previously, the term “payroll funding” can sometimes be used rather loosely and may actually mean factoring or a variety of other types of loans.
Now that we’ve covered the nuances of these different types of loans and compared the differences between factoring and payroll funding, you can make the decision that works best for your business. At Payro Finance, that is ultimately our goal – helping you, the business owner, achieve success.