Financing for payroll: How to pay salaries in a cash flow crunch
Not having the cash to pay workers’ wages isn’t a situation any business wants to find itself in. But meeting your payroll obligations can sometimes be challenging, even when your company is thriving.
Payroll financing is an option that enables businesses of any size to secure the funds they need to sustain their operations during a cash flow crunch or slowdown. This type of funding is particularly useful for small businesses that have limited cash reserves, but many employees on payroll.
It’s really about a sales cycle for a business. Very often, clients will pay businesses every 30, 60 or even 90 days, but employees get paid every two weeks.
Nadia Forgione
Manager, Virtual Business Centre, BDC
When to consider a loan to fund your payroll
Nadia Forgione, Manager in the Virtual Business Centre at BDC, says a small business should consider its financing options when its cash flow doesn't match its payment schedule. “It’s really about a sales cycle for a business. Very often, clients will pay businesses every 30, 60 or even 90 days, but employees get paid every two weeks.”
She gives the example of a daycare provider.
“What happens is that the payments are coming in from the parents on a monthly basis. So the daycare’s cash flow can become quite tight because it has to pay its employees every two weeks.”
Many businesses also consider financing payroll when they are expanding or starting up. In such cases, Forgione suggests businesses look to one of several financing options.
What options are available to finance payroll?
Several different types of business credit are available to cover employees’ wages and benefits.
- Small business loan
This short-term financing can help you bridge financial gaps and pay for everyday operations, like wages and other activities. - Line of credit
Also known as a bank operating loan, this is a short-term, flexible loan that you can use to borrow a preset amount of money. It can help bridge funding gaps for ongoing expenses. - Merchant cash advance
Also known as a business cash advance, this lets you borrow against your future credit card transaction revenue. - Purchase order financing
This is another type of short-term loan that provides your business with the liquidity it needs to pay its workers while fulfilling a large order or contract.
Forgione says using a line of credit is often the best option for financing payroll, as long as you know you’ll have the money to pay your employees the next month (as in the daycare example). But if you’re looking to expand your business and need to hire new employees, she says a small business loan is the safest bet.
What you need to apply for a loan
It’s important to do some homework to craft a winning loan request. The first step is to gather any documents your banker will need to assess your request. These could include:
- Financial statements
Banks typically review financial statements to understand a company’s financial health, profitability and capacity to repay debt. For larger loans, statements are needed for the preceding two years, along with interim statements comparing the latest sales period with the same period in the previous year. - Financial projections
Banks also often want to see a monthly cash flow forecast for the remainder of the current year and the following 12 months. In some cases, they may ask for two years of projections.
Forgione says a bank or lender, such as BDC, is generally comfortable taking on more risk when the loan is less than $100,000. For example, BDC has a small business loan that is usually available quickly via an online application and doesn’t usually require you to provide financial statements or other paperwork.
The best way to avoid a payroll loan is to stay within your means and within what your operations need.
Nadia Forgione
Manager, Virtual Business Centre, BDC
How to avoid payroll loans
Ensuring you always have the cash to pay employees is the ideal situation for any business. “The best way to avoid a payroll loan is to stay within your means and within what your operations need,” says Forgione.
She suggests most businesses keep enough money in the bank to pay about three months’ worth of salaries. Having that cushion will ensure you’re never in a situation where you’re unable to pay workers.
Another key piece of advice is to make sure you hire only as many employees as you actually need to run your business. Forgione suggests hiring temporary workers if you know your business will need extra help for a specific and limited time period, such as during the summer months or holiday season.
Proper planning is also critical, says Forgione. By keeping on top of your finances—and having a thorough understanding of the money that is coming in and going out—you can prevent your business from facing a cash flow crunch.
Know how to manage your cash flow
Discover ways to manage your business’s cash by downloading BDC’s free guide, Taking Control of Your Cash Flow.