Small business owners are consistently urged to monitor their finances to avoid cash flow crunches. But sometimes, you have little if no control over the time it takes for cash to flow in and out of your business. You might find that cash is flowing out a lot quicker than it is flowing in. This is just one of many circumstances that could deprive you of the funds required for paying your employees on time. Projects can get delayed, rough patches can last a little longer than usual, and other operational costs can skyrocket out of nowhere. You need cash fast, and must therefore contact a business lender.
Only then, however, do you discover that there are no longer just a few types of small business loans to choose from. Luckily, talking to an unbiased financing company like United Capital Source will tell you that certain options are more appropriate for making payroll than others.
1. Business Line of Credit
Plenty of industries are naturally prone to occasional but unpredictable dips in revenue. Demand can change at the drop of a hat or a sudden bout of bad weather can ruin a traditionally busy period. If this sounds like your business, then your best option for covering payroll is likely a business line of credit. Unlike a credit card, you only have to make payments when you borrow money, and the only interest you’ll be responsible for comes from the money you’ve borrowed. The longer you take to pay back the total amount you’ve borrowed thus far, the more interest accrues. But once you pay back that total amount, you will likely gain access to that same amount all over again.
The terms of a business line of credit suggest that it is best suited for small to medium sized short-term investments. Think about it: Larger amounts take longer to pay back, especially if additional revenue isn’t coming in anytime soon. And even though you can technically borrow from your credit line at any time for any purpose, the most convenient terms are usually given to applicants who pursue lines of credit before they actually need them. Business lenders therefore advise potential borrowers to apply when cash flow is strong.
2. Accounts Receivable Factoring
If your business model revolves around invoices, you’re probably all-too-familiar with clients who fall behind on payments or don’t pay them in full. Insurance providers are notorious for delinquent payments, leaving doctors without enough money to make payroll for weeks or even months. This is why an increasing amount of business lenders now offer accounts receivable factoring, or invoice financing. The borrower sells the unpaid invoice for a discount price, essentially shortening your business cycle to just a few business days. It is then up to the business lender to collect the payment from the client or insurance provider. Once that payment is collected, the business lender pays the borrower the remainder of the total cost of the invoice, minus a second discount. Some business lenders charge additional interest based on the time it takes the client or insurance provider to pay up.
Another reason accounts receivable factoring is so highly recommended is that it technically is not classified as “loan” and will not show up as “debt” on your balance sheet. This allows borrowers use accounts receivable factoring many times, possibly even once a month, without ruining their business credit.
3. Working Capital Loan
There are several types of working capital loans. The one thing they all have in common is that their amount is based on the costs of regular business expenses, or how much “working capital” you need to run your business. Unlike business lines of credit, working capital loans are also more accessible to applicants with less than stellar credit or cash flow. This makes working capital loans more expensive, but their flexible terms often do not force borrowers to make substantial payments right away. So, while there are short-term working capital loans that can be paid back in as little as four months, the most flexible working capital loans are used for long-term investments. These working capital loans are typically recommended for borrowers looking to cover payroll for longer periods of time, like an entire slow season.
In this case, the additional revenue required to pay off the debt isn’t expected to come in for a number months. That revenue should be on the higher side, since slow periods must be followed by busy periods in order to stabilize finances for the year.
As you can see, the business loan you choose largely depends on the amount of money you need, the amount of time that will elapse before revenue flows in, and how often you will find yourself in this same situation again. The process of taking out a business loan to cover payroll should also show you how to avoid this specific type of cash flow crunch. If you’re having trouble making payroll without additional business funding, it might be time to revisit your budget and a keep a closer eye on your profit and loss statements moving forward.