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Originally Posted On: http://www.smallbusinessbrief.com/financial/what-are-payroll-funding-companies-and-how-do-they-work/

 

It doesn’t matter how profitable your company appears on the books, you can still run into cash flow problems from time to time.

And, having a positive cash flow is vital for the operations and success of your business.

So what do you do when this happens? Do you just stop paying your bills? Do you stop giving your employees their paychecks? Do you stop purchasing supplies and inventory?

These really aren’t good solutions. In fact, they’d leave you with different problems.

There is a good solution, though, and this solution is offered through funding companies. A funding company offers a service called payroll financing, and this service can instantly solve your cash flow problems.

Are you curious about how this works? If so, let me explain the important things to understand about it.

The Importance of Cash Flow

First off, cash flow describes the way cash flows in and out of your business, and it can be positive or negative. Cash flow basically measures the amount of cash coming in for the month to the amount of cash going out.

Let’s look at a simple example of this. If your company received $5,000 this month for sales and paid out $4,000, you’d have a positive cash flow because you have $1,000 more than the amount you needed to spend.

On the other hand, imagine if your expenses for the month were $7,000. In this example, you’d have a negative cash flow of $2,000 because you spent $2,000 more than the amount you collected.

Experiencing negative cash flow can impact your business in several ways. One, it may cause you to pay your bills late. Two, it may impede your growth. Three, you may rack up more debt by turning to loans with high-interest rates.

Negative cash flow doesn’t do a business a bit of good yet tends to be a common problem among business owners.

Where Most Companies Experience a Problem

So, why do companies experience cash flow problems? Better yet, why do good, profitable, and strong companies experience cash flow problems?

There can be all kinds of explanations for this, but the most common reason it occurs is due to their accounts receivable accounts.

An accounts receivable account allows a customer the ability to receive goods or services now but pay for them later. If you provide services or goods for your customers and then bill them, how much time do you give them to pay their bills?

You might give them 30 days or possibly 60 days. You could even give them 90 or 120 days.

The problem with this is that your bills and payroll expenses will continue accumulating, and you might not have 30 to 120 days to pay these things. Instead, you’ll have to pay them now.

If you have all this money on your books that people owe you, it’s considered an asset because it’s money owed to you but it’s not money in your pocket that you can currently use.

From the time you provide goods and services on credit to the time you actually receive the money for these invoices, a lot of time can pass by.

This tends to be where the problem of negative cash flow often originates.

The Basics of What Funding Companies Do

Companies that have cash flow problems due to accounts receivable billing terms can greatly benefit by using the services of a funding company. A funding company provides payroll financing services.

Payroll financing services are designed to help your company make its payroll costs and other immediate expenses by loaning you money for your accounts receivable accounts.

This service is often called accounts receivable factoring due to the nature of how it works, and here are the two main steps involved in the process:

1. You Sell Your Accounts Receivable Accounts to the Funding Company for an Upfront Payment

Payroll financing involves selling the accounts receivable accounts you have to the funding company. After they review the accounts, they actually buy them from you.

When this occurs, they will generally pay you a certain percentage of the value of these accounts which might be anywhere from 80% to 95%.

The funding company will likely pay you the money within just one day of completing the agreement. After accepting the payment, you would no longer own these accounts. They would belong to the funding company.

The funding company is then responsible for collecting the money from these accounts.

2. They Pay You the Remaining Balance After Collecting the Money Owed

The second steps occurs when the funding company collects the debts from the accounts you sold them. When they receive money from the accounts, they will pay you the rest of the money they owed you for them.

They will subtract a fee from this portion, though. This fee is the money a funding company earns as income, and it may be around 1% to 3% of the total amount of the original invoice.

The Benefits This Offers

Now that you understand the basic principles of how payroll financing works, you can probably see the benefits of using this service.

The bottom line is that you are basically using this service to not have to wait to get paid by your customers.

You can continue offering credit accounts to your customers, but you would no longer be impacted with negative cash flow as you wait for the payments to come in.

This service would provide you with a positive cash flow that would allow you to keep paying your bills and all your payroll expenses.

How You Can Use Payroll Financing to Solve the Problem

Using the services of funding companies is one of the best ways to solve cash flow problems, and one of the best parts about it is that this really is not a loan.

In other words, you won’t have to repay the money you received from the company. You sold your accounts receivable for cash, so you’re really not borrowing money. You’re just receiving money in advance that you would normally receive.

Does this sound like a great solution for you? If so, check out our blog to learn more about how payroll financing works.