Are Payroll Loans Right for your Business?
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Payday is coming up and your small business doesn’t know if you can cover your commitments. Customer receipts have lagged, or a major invoice is unpaid. An unexpected, emergency expense came up and you had to dip into your payroll account to cover it.
Whatever the reason, it’s looking likely that you won’t have the funds to pay your employees on payday. Which could have serious repercussions for your business.
When employees become concerned about your business’ cash flows, they could start looking for work elsewhere. Losing top talent forces you to spend money attracting and training new talent. If the larger community learns you failed to pay employees on time, your reputation will suffer.
The solution could be taking out a payroll loan. But before you apply for one, make sure it’s the right choice for your business.
What are Payroll Loans?
Payroll loans are short-term loans meant to help out small business owners in a pinch. Lenders can approve the loans in a few days and borrowers can receive funding in 24 hours. Their quick approval process and funding time makes them ideal for small business owners who face an emergency need.
When is a Payroll Loan Right for your Business?
Under some circumstances, a payroll loan will pay off for your business in the long-term. Here’s when you can be reasonably assured it’s a wise decision.
When it will help you keep employees
It’s not just your business’ budget that you need to worry about, employees have personal budgets to manage their finances. They count on being paid on time to cover rent and mortgages, car payments, and other obligations.
If you’ve failed to make payroll in the past, have bounced checks, or have created any uncertainty in them about your business’ financial stability, there’s a strong possibility they’ll start looking for work elsewhere if you fail to pay on time.
For some businesses that depend on a highly-trained workforce, high turnover can become a real issue. Recruiting, training, and replacing lost employees could use resources you’d planned to put towards an expansion or other business initiatives. It could further harm business cash flow funding. If a payroll loan will help you retain key employees, it’s worth it for your business.
When it will protect your reputation
Employees will talk, they will fill out surveys on websites, and they will grumble where customers can hear. A failure to pay on time will not stay within the business, and neither will bouncing checks or other financial issues. As word spreads throughout the local and business community, it can impact your business’ reputation.
Customers may think less of you because you’re not paying your employees, and take their business elsewhere. Potential hires will read online reviews and be reluctant to consider you as an employer. Vendors could become concerned about your business’ stability and offer less favorable terms.
If these concerns would apply to your company, apply for a payroll loan to protect your reputation.
When you can afford the loan
Anytime you take a business loan, have a plan to pay the money back. Ask the payroll lender to provide you with an estimated repayment amount. Add the new loan’s payment to your budget and see how it will impact your business’ cash flows going forward.
Can you cover the payments once customers pay their past due invoices, and are you reasonably assured that they will pay? Do you have room to still meet your obligations, including the loan’s payment, if sales dipped and on-time customer payments continued to be an issue?
You should only borrow if you know you can repay the loan over the next few months.
When you need money quickly
It’s Wednesday, payday is Friday, and you’ve just realized you don’t have the cash on hand to pay your employees.
You won’t have time to apply for and receive approval for a short-term business loan from a traditional lender. Your business credit card doesn’t allow a large enough cash advance. When you need money to cover payroll and don’t have time to shop around for lenders or wait weeks for loan approval, a payroll loan is a great choice.
When you have bad credit
Even if you do have time to apply with a traditional lender, you might not qualify. If cash flow issues with the business and borrowing have damaged your credit score, getting approved for traditional financing could be difficult. A payroll loan allows you to still access the capital you need.
Alternative lenders who offer payroll loans will extend credit to borrowers with scores as low as 530. Your business must generate minimum monthly revenues of $10,000 to qualify, but because payroll lenders care more about revenues than credit score it’s easier to qualify for any type of bad credit business loan.
When is a Payroll Loan Wrong for your Business
There are times when you should think twice about a payroll loan, and perhaps consider a different loan product. Here’s when a payroll loan could be wrong for your business.
When you need to cover other working capital needs, too
Working capital is the funds needed to keep the doors open and the lights on. These expenses include rent, utilities, and payroll. If you’re struggling to cover other expenses, too, a payroll loan might not be the right choice.
Some payroll lenders might restrict the loan’s funds to just covering payroll. Consider taking out a working capital loan instead of a payroll loan if you need the freedom to use the loan’s funds for other needs.
When the interest rate is too high
Lenders approve payroll loans quickly, often on just the basis of your credit score and your business’ monthly revenues. While this makes these loans perfect for an emergency need, this means that the lender is taking on more risk. Without performing a full underwriting process, they have less certainty that you’ll repay the loan.
Lenders compensate for risk by charging higher interest rates and shortening the repayment term. The rates on a payroll loan will be higher than you’d pay for other forms of credit. Most alternative lenders charge between 9% and 45%.
When you can’t afford the payment
A high interest rate and a shorter repayment term will lead to a large repayment amount. When you borrow, you have a set amount of time to repay the loan. A longer repayment term equates to smaller payments, and vice versa.
Here’s how that works. Using simple numbers, let’s say you borrow $15,000 and have to repay it over a year. Your monthly payment would be $1,250. But if you have to repay it over three months, your monthly payment is $5,000.
Most payroll lenders have repayment periods of less than a year. When the payroll lender quotes you a loan’s terms, take a hard look at the repayment schedule and amount. Can your business’ cash flows support that payment amount? If not, look elsewhere to solve your cash flow problem.
When it could hurt your credit score
Taking on more debt could lower your credit score, making it harder to qualify for financing in the future. Before you borrow, see if you could generate funds elsewhere – such as following up on past due invoices. A lender’s credit check will drop your score five points, even if you’re not approved for the loan.
Not all payroll lenders report to credit bureaus, and some only report if you miss payments or default. It’s not a guarantee that a payroll loan will impact your credit score beyond the initial credit check, but you should still consider the possiblity.
When the payroll loan hides deeper problems
Borrowing to cover a short-term, emergency need can often hide deeper issues in your business. Before you borrow, ask yourself why you’re in this situation. Using loans to solve temporary cash flow issues on a recurring basis could put you in a debt cycle that’s difficult to break unless you address underlying business problems.
Perhaps your accounts receivable department isn’t following up on past due invoices, or enforcing late fees. Maybe you need to enforce stronger collections practices to ensure customers pay, or pay on time. The issue could come from underperformance in the sales department, and you might need to replace key personnel or offer better sales incentives.
While you might still decide to take out the payroll loan, you should also work to fix the reasons you need to borrow.
Is a Payroll Loan Right for You?
Once you examine the pros and cons of payroll loans and look at your business needs, it’s probably obvious which is the right path to take. If it’s time to take out a payroll loan, contact Shield Funding today. We offer quick funding, no prepayment penalties, and simple and easy repayment plan.