Payroll Loans: Everything You Need to Know

Ezra Cabrera | January 31, 2022


    Key Takeaways

    • Payroll loans can provide you with the funds you need to pay your employees in full and on time, and they are available to small and medium-sized businesses.
    • Payroll loans can provide you with the funds you need to pay your employees in full and on time, and they are available to small and medium-sized businesses.
    • If you take out a payroll loan, then you will most likely have the money in your bank account within one business day of applying. However, they can be very expensive, and the payroll funding company will want to be reimbursed as soon as possible.

    Payroll Loans: Everything You Need to Know

    A payroll loan is a type of funding that assists businesses in making payroll payments to their employees. Many types of financing, such as lines of credit and invoice financing, can be used as payroll loans because they can be funded quickly enough to cover your payroll costs and other expenses. Payroll is treated as a general working capital expense by the majority of lenders, which is why these small business loans are frequently referred to as working capital loans.

    Payroll loans can provide you with the funds you need to pay your employees in full and on time, and they are available to small and medium-sized businesses. Payroll loans are typically issued by online alternative lenders due to the short funding time required by payroll loans.

    Payment plans for payroll loans are structured differently depending on the type of payroll loan you choose. Payroll loans, on the other hand, are typically for a period of one year or less, with interest rates that vary. Payroll loans will have higher interest rates than other types of business loans due to the fact that they are short-term in nature and can provide immediate funding.

    The Benefits of Payroll Loans

    If you find yourself in a situation where you lack the cash to cover payroll, you may be able to benefit from obtaining a payroll loan from a lender.

    As mentioned, payroll loans allow you to borrow a small amount of money in order to ensure that your employees are paid on time on a regular basis. If you take out a payroll loan, then you will most likely have the money in your bank account within one business day of applying. However, they can be very expensive, and the payroll funding company will want to be reimbursed as soon as possible.

    Furthermore, payroll loans should not be confused with payday loans, which are short-term consumer loans with an average interest rate of 400% that charge borrowers a high rate of interest. Indeed, in some states, payday loans are not even permitted, as is the case with payroll loans.

    Who Should Apply for Payroll Loans?

    If you find yourself in a tight financial situation, then a payroll loan should be your last resort.

    You should first weigh all of your options before considering a loan from a payroll financing company because interest rates on payroll financing solutions can reach a staggering 30%.

    However, there are some situations wherein a payroll loan is highly beneficial. Here are examples of situations where a payroll loan could be beneficial to your small business:

    1. You are experiencing a short-term cash flow problem.

    When you own and operate a small business, cash flow is not always a smooth and predictable cycle. When you have to pay for a large business expense (such as an equipment repair), you may find yourself in a cash crunch.

    If you know that you will be paid by a customer in less than a month, a short-term loan may be able to help you maintain the stability of your cash flow.

    2. You’ve increased the number of employees.

    It is possible that you will experience funding fluctuations between your slow and busy seasons if you own a seasonal business.

    When operating a coastal vacation rental business, for example, paying a staffing agency to recruit employees for the summer season could be beneficial.

    However, if you hire new employees before the busy season begins, you may find yourself with insufficient funds to pay them. Fortunately, a payroll loan can bridge the gap, ensuring that all employees are paid in time for the summer rush.

    3. You have not been approved for traditional funding options.

    In the event that you are unable to obtain approval for traditional business loans but are required to pay your employees as soon as possible, a payroll loan may be your only option. Payroll loans with interest rates ranging from 15-30%are preferable to the consequences of failing to pay your employees on time.

    Meeting Payroll Requirements

    Aside from payroll loans, there are also other funding options that will allow you to meet your payroll needs. Here are some of them:

    Short-Term Business Loans

    Even if you find yourself in the middle of an emergency or facing a sudden influx of invoices, then you must still pay your employees on time. When this happens, small business short-term loans can be a very useful tool.

    Though these loans are not the most affordable options available on the market, they can provide quick business financing quickly and thus are a viable option.

    Business Lines of Credit

    A business line of credit allows businesses access to funds through a revolving loan. It may be necessary to take out a business line of credit if a large, unexpected expense will prevent you from meeting your payroll obligations for more than a few weeks or months.

    Business lines of credit, in contrast to short-term loans (which typically have terms of up to a year or less), are more accessible. Since they are revolving loans, funds are accessible whenever you want or need them. Also, you will only be charged interest on the money that is actually spent from the credit line. Once you have paid off the amount you have spent, your line of credit will be restored to its original amount.

    Because of their flexibility, business lines of credit are ideal financing solutions for most businesses to have on hand, regardless of their financial concerns. This is why business lines of credit are ideal financing solutions for most businesses to have on hand. You can use your line of credit to pay for inventory, fill cash-flow gaps, invest in new marketing materials, and pretty much any other working capital expense as long as it falls within the range of your assigned loan amount and you are confident in your ability to repay your debts.

    Invoice Financing

    Invoice financing is a type of funding option that allows you to borrow money by selling your invoices. If you run a B2B company that is waiting on a batch of outstanding invoices, invoice financing may be the most cost-effective way for you to recover that cash and pay your employees’ wages.

    With invoice financing, a lender makes a cash advance to you–usually 85% of the value of your outstanding invoices. Until your customer pays you back, the lender will defer payment of the remaining 15%, and in the meantime, they may charge you fees based on the percentage of the loan that remains unpaid.

    Despite the fact that these payroll loans are more easily obtained, they are frequently more expensive. If you are a newer business with a shorter credit history or a lower credit score, you will be much more likely to qualify for this type of financing because invoice financing companies are often more concerned with the value of your invoices and the history of payment from your customers than they are with the financial health of your company and its credit rating.

    Avoiding Payroll Loans

    It’s good to remember that In the future, you should always avoid taking out payroll loans. These loans are expensive and should only be used as a last resort, rather than a regular financing option. Emergencies will inevitably occur, but taking the steps listed below can help you avoid relying on payroll loans.

    This is why it’s important to make a plan for both the ups and the downs that your business may face. Almost every small business owner agrees on the importance of having a well-planned budget in place. For the most part, it’s a good idea to be overly cautious when creating a budget and to account for unexpected expenses when making cash flow projections.

    To do this, you should be able to forecast a minimum of one month in advance and include projections for 20% above and 20% below the current level of performance. Even if you are 20% below your forecast, your forecast should always be sufficient to cover payroll. If your cash flow projections show that you will be able to make loan payments and pay your employees in the future, you should consider taking out a loan.

    You should also make provisions for potential payroll issues. Following the completion of your projected financials, you can begin accumulating a cash reserve. After all, having a little extra cushion in your bank account is always beneficial. If your company makes $5 in revenue, then you could put $2 into a business savings account for every $5 earned. This way, when the time comes that you require additional funds, you will have them readily available.

    In the event that you require assistance in keeping track of your financials and developing a budget, you may want to consider investing in business accounting software that is as simple and intuitive to use as it is feature-rich.

    Finally, ensure that you communicate with your employees. Even after careful planning and saving, you may find yourself in a position where you are unable to pay your employees’ wages at some point during the course of your business. It will be critical to maintain open lines of communication with your employees if that time comes, and you should reassure them of your compensation plan.

    While having an open and honest conversation with your employees may not prevent you from incurring a payroll loan, it can help them feel valued and secure in their position. Talking about the issues that contributed to the shortfall can help you develop a strategy for addressing those issues and ensuring that they don’t happen again.

    Consider presenting your employees with hard financial evidence, such as your budget plan and cash-flow forecast, to demonstrate your commitment to them. As a result, you will be able to demonstrate to your employees exactly why and how your financials became out of control, as well as how a payroll loan (or other financial solution) will fit into your revised budget.

    Final Thoughts

    Any business owner would want to have enough money to cover payroll expenses. However, there may be situations that come unexpectedly. Surprise expenses, sales declines, and missed invoice payments can all throw even the most meticulously planned budgets off course, and it can take a significant amount of time and effort to get your business back on track.

    This is why if you’re in need of quick solutions to meet payroll requirements, then you should consider applying for a payroll loan. However, there are also other funding options, such as short-term loans, business lines of credit, and invoice financing.

    About the Author

    Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.