What is Payroll Factoring?
Payroll factoring is a type of accounts receivable factoring that is specifically designed 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 a third-party company in exchange for 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 its employees. It’s an alternative funding method when businesses can’t qualify for bank loans.
Staffing companies often turn to payroll factoring as a solution to mitigate the risks of missing payroll, which can compromise employee retention. Payroll factoring enables businesses to pay their staff promptly while awaiting payment from clients for services rendered.
What is a Payroll Factoring Company?
A payroll invoice factoring company is a financial services provider that offers invoice factoring for staffing companies. You might see them listed as a payroll funding company or payroll finance company.
Some payroll factoring companies focus exclusively on payroll funding services, while others offer it as one of several business funding products. There are many factoring companies to consider. Working with a full-service payroll factoring company can provide additional services, such as assistance with payroll taxes.
Businesses seeking invoice factoring services typically sign a factoring agreement with the payroll funding provider. Some payroll financing companies require the company to use their payroll processing services.
How does Payroll Invoice Factoring 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.
With payroll factoring, staffing agencies can receive up to 100% of invoice value within 24-48 hours, providing timely funding for payroll. The fees associated with payroll factoring typically range from 1% to 5% of the total invoice amount, depending on factors such as the client’s creditworthiness.
Payroll Invoice Factoring Definitions:
Here are some key terms to know to understand the factoring process:
- Advance rate: The percentage of the invoice value that the factoring company issues. Advance rates range from 75%-95%. Payroll funding can provide a cash advance of up to 93% on outstanding invoices to cover payroll expenses before clients pay.
- 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 that 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:
- Step 1: Deliver goods or services and issue the invoice: Your business completes a job or delivers services to your customer, just like usual. You then issue an invoice detailing the amount owed and the payment terms, typically net 30, 60, or 90 days. At this point, your receivable is created and eligible for factoring.
- Step 2: Submit the invoice to the factoring company: Instead of waiting for your customer to pay, you send the open invoice(s) to the factoring company. Many factoring companies offer online portals or integrations that make uploading invoices fast and simple.
- Step 3: Invoice verification and advance Funding: The factoring company verifies the invoice, typically confirming that the customer has received the service and accepts the terms. Once approved, the factor provides an immediate cash advance, usually between 75% and 95% of the invoice’s value, often within 24 hours.
- Step 4: Receive funds and run payroll: You receive the advance directly in your business bank account. These funds can be used immediately to cover payroll expenses, taxes, or other operating costs. This eliminates the cash flow gap between service delivery and client payment.
- Step 5: The factoring company collects payment: Your customer now pays the factoring company, as per the terms of the invoice. The factor handles the collection process, including follow-ups, payment processing, and account reconciliation, which can reduce your administrative workload.
- Step 6: You receive the reserve minus the factoring fee: Once your customer pays in full, the factoring company releases the remaining reserve amount (the portion held back from the advance), minus their factoring fee. The fee typically ranges from 1% to 5%, depending on the invoice size, the client’s creditworthiness, and the time it takes for your customer to pay.
Staffing Factoring
Many staffing companies utilize payroll factoring services to offset their expenses. Factoring for staffing is especially useful for a startup staffing company that might not have the cash available to cover costs.
When a staffing agency sends staff to one of its clients, it bills the client for the hours worked by those staff members. Terms for payroll invoices can range from 30 to 90 days. A company might choose a staffing company with longer payment terms because it gives them more time to pay. The staffing company’s customers typically prefer longer payment terms.
However, the staffing company typically pays temporary employees on a weekly or biweekly basis. Payroll funding enables staffing companies to issue payroll on time, providing their clients with additional time to settle their payments. Factoring can help staffing businesses maintain a steady cash flow, enabling them to meet payroll consistently.
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 and expenses. 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. Unlike traditional loans, payroll factoring does not require businesses to provide physical assets as collateral; instead, it relies on the creditworthiness of the clients.
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 offer convenient online applications and expedited funding times once the factoring process is established.
Payroll funding also alleviates some of the pressure on the business to collect payments 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’s discount fee means your business is not receiving as much revenue as it could. The fee also applies to every invoice term that remains unpaid, meaning late-paying customers will increase your costs. 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 and trustworthy. You may not get approved if your customers have poor credit or a history of late invoice payments.
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, and debt schedule.
Step 3: Apply
You can complete our one-page application or contact us by phone 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 contact you to discuss the factoring fee, factoring rate, and terms associated with 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 critical in the staffing industry, any company that sells on credit and employs staff could benefit from this service.
Is Payroll Factoring the same as Payroll Financing?
The terms “payroll factoring” and “payroll invoice financing” are often used interchangeably; however, they’re technically two distinct funding structures. Payroll factoring is a transaction where a business sells its unpaid invoices to cover payroll costs.
Payroll invoice financing is a loan that covers payroll costs, secured by a company’s accounts receivable as collateral. Unlike factoring, payroll loans incur debt, and the company repays the loan amount.
<h2id=alternatives>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 financing
- SBA loans
- ERTC advance
How to Use Payroll Factoring – Final Thoughts
Payroll factoring is a viable option for business owners to avoid late payments to their employees. 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 further questions about payroll funding or would like to apply for receivables factoring. Our business funding experts can help you get set up.
