What is Payroll Factoring?
Payroll factoring is a form of invoice factoring specifically to cover payroll costs. You may see the service listed as “staffing factoring,” “payroll funding,” “payroll invoice financing,” or “payroll invoice factoring.”
The process involves selling the unpaid invoices to receive immediate funds to pay employee wages. Staffing companies and temporary employment agencies often use payroll funding, but any small business can use this method to pay their employees. It’s an alternative funding method when businesses can’t qualify for bank loans.
What is a Payroll Factoring Company?
A payroll invoice factoring company is a financial services company that provides the factoring service. You might see them listed as a payroll funding company or payroll finance company.
Some payroll factoring companies focus exclusively on factoring, while others offer it as one of several business funding products. There are many factoring companies to consider.
Businesses seeking factoring services typically sign a factoring agreement with the company. Some payroll financing companies require the company to place payroll processing with them.
How does Payroll Funding work?
Payroll invoice factoring is not a loan. It’s a business-to-business transaction. The company sells, or “factors,” the invoice to a factoring company.
Payroll Invoice Factoring Definitions:
Here are some key terms to know to understand the factoring process:
- Advance rate: The percentage of the invoice value the factoring company issues. Advance rates range from 75%-95%.
- Reserve Amount: The remaining percentage of the invoice after the advance is issued (so 10% reserve if the advance rate is 90%).
- Discount rate: The percentage of the invoice the factoring company keeps as its service fee. Also called a factoring fee. Discount rates are usually 1%-3% per invoice term.
Payroll Invoice Process:
Once you sign an agreement with a factoring company, the process works like this:
- Step 1: Deliver goods and services to your customers and issue an invoice.
- Step 2: Send the invoice to the factoring company.
- Step 3: The factoring company approves the invoice and issues an advance at the advance rate.
- Step 4: You receive the money and use it to make payroll.
- Step 5: The factoring company collects payment from your customers.
- Step 6: After the client pays, the factoring company sends you the reserve minus its fee.
Staffing Factoring
Staffing agencies frequently use payroll invoice factoring to cover their costs. Factoring for staffing is especially useful for a startup staffing company that might not have the cash available to cover expenses.
When a staffing agency sends staff to one of its clients, it bills the client for the hours worked. Terms for payroll invoices can be 30, 60, or 90 days. A company might choose a staffing company with longer payment terms because it gives them more time to pay.
However, the staffing company will typically pay temporary employees weekly or biweekly. Payroll funding allows staffing companies to issue payroll on time while giving their clients more time to pay.
What are the advantages of Payroll Factoring?
The primary benefit of payroll invoice factoring is that it frees up working capital to cover employee wages. That, in turn, helps small businesses attract and retain top talent.
Payroll is one of a business’s most significant costs, and factoring helps smooth out cash flow. That means companies don’t have to dip into cash reserves to cover the costs.
Since it’s a B2B transaction, not a loan, invoice factoring is typically available for business owners with less-than-perfect credit. Most payroll factoring companies also provide convenient online applications and fast funding times once the factoring process is set up.
Payroll funding also takes some of the pressure off the business to collect payment from its customers. The factoring company is responsible for collecting payment once it accepts the invoice.
What are the disadvantages of Payroll Factoring?
The most significant drawback to payroll funding is the cost. The factoring company discount fee means your business is not receiving as much revenue. The fee also applies every invoice term it remains unpaid, meaning late paying customers will drive your costs up. Most short-term loan or funding options are more expensive.
Since the business’s customers are the source of repayment, factoring companies typically only work with businesses whose customers are reliable. You might not get approved if your customers have poor credit or a history of paying invoices late.
Payroll Factoring Pros & Cons
Pros:
- Helps businesses pay employees on time to attract & retain top talent.
- Helps maintain consistent cash flow without using cash reserves.
- Usually available for business owners with fair credit.
- Not a loan, so it doesn’t incur debt.
- Convenient online applications with fast funding.
- The factoring company collects payment from your customers.
Cons:
- Most forms of invoice factoring are expensive.
- Fees depend on when your customer pays.
- Your customers need good credit for you to qualify.
How can I get Payroll Factoring?
You can apply for payroll invoice factoring through United Capital Source. Follow these instructions to obtain payroll funding.
Step 1: Make Sure Your Customer is Reliable
Factoring invoices only works when your customers pay their invoices on time and in full. Ensure you’re certain your customers will pay before contacting a factoring company.
Step 2: Gather Your Documentation
When you apply, the factoring company needs to review the following documents:
- Driver’s license.
- Voided business check.
- Bank statements from the previous three months.
- Business tax return.
- Accounts receivable aging report, Accounts payable report, debt schedule.
Step 3: Apply
You can complete our one-page application or give us a call to apply. Either way, you must provide the information above and the invoice amount you want to sell.
Step 4: Speak to a Representative
Once you apply, one of our representatives will reach out to discuss the factoring fee, factoring rate, and terms attached to the sale. You’ll get an upfront breakdown of all costs, so you don’t have to worry about hidden fees.
Step 5: Receive Approval
The entire process takes about two weeks to finalize. Funds will appear in your bank account 1-2 days after completing the application.
Frequently Asked Questions
Here are the most common questions about payroll factoring.
Who should use Payroll Funding?
While payroll funding is especially important in the staffing industry, any company that sells on credit and has employees could benefit from the service.
Is Payroll Factoring the same as Payroll Financing?
The terms payroll factoring and payroll invoice financing are often used interchangeably, but they’re technically too different funding structures. Payroll factoring is a transaction where a business sells its unpaid invoices to cover payroll costs.
Payroll invoice financing is a loan to cover payroll costs that’s secured using a company’s accounts receivable as collateral. Unlike factoring, payroll financing incurs debt, and the company repays the loan amount.
What are my alternatives to Payroll Factoring?
Multiple working capital loans are available if payroll invoice factoring isn’t a good fit for your business. You might also be interested in one of the following small business loans:
- Bad credit business loans.
- Business line of credit.
- Business loans for women.
- Business term loans.
- Equipment financing.
- Merchant cash advance.
- Revenue-based loan.
- SBA loans.
- ERTC advance.
How to Use Payroll Factoring – Final Thoughts
Payroll factoring is a viable way for a business owner to avoid paying their employees late. It helps keep your business legally compliant while maintaining high employee satisfaction.
However, you should be prepared for the extra costs. It’s not a permanent solution in most cases and should be used to help overcome temporary working capital issues.
Contact us if you have more questions about payroll funding or want to apply for factoring. Our business funding experts can assist you with getting set up.
