Payroll Factoring

Who Payroll Factoring Fits

It tends to work best for businesses with:

• Business or government customers with good payment records

• Invoices for completed work rather than progress billing or heavy retainage

• Frequent payrolls and gross margins wide enough to absorb the fee

• Growth that is outpacing what a bank is willing to lend

It fits poorly when customers are consumers, when invoices are often disputed, or when margins are so thin that the fee would wipe out the profit on the work.

Benefits and Drawbacks

• Benefit: approval based on customers. Newer or thinly capitalized companies can qualify if their customers are creditworthy.

• Benefit: grows with sales. More invoices mean more available cash, without a new application.

• Benefit: no fixed payment schedule. Each advance is settled when your customer pays.

• Drawback: cost. It is usually more expensive than a bank line of credit.

• Drawback: a third party in your billing. The factor will be part of your invoicing and collections.

• Drawback: contract terms. Minimum volumes, long terms and exit fees can make switching difficult.

Payroll Factoring vs a Payroll Loan

A loan is debt. It is approved mainly on your own credit and cash flow and repaid on a fixed schedule whether or not customers have paid you. Factoring is a sale of receivables. It is approved mainly on your customers' credit and repaid by those customers.

A loan may cost less and keeps your customers out of the arrangement. Factoring is easier to obtain when you are young or growing quickly, and the cash available rises with your sales. Many businesses start with factoring and move to a bank or asset-based line once they build a longer track record.

Frequently Asked Questions

How quickly can I get the first advance?
Opening an account involves an application, lien searches and customer verification, which can take from a few days to a couple of weeks. Advances on later invoices are typically much faster.

Will factoring show up as debt?
Because it is generally a sale of invoices, it does not usually appear as a new loan. The UCC filing is public, though, and other lenders will see it.

Can I factor only some invoices?
Some factors allow spot or selective factoring of single invoices or customers. Others require all invoices from approved customers. Selective arrangements often cost more per invoice.

What if my customer disputes an invoice?
Resolving the dispute is usually your responsibility, and the factor may charge the invoice back or hold it against your reserve until it is settled.

Explore Your Financing Options

If payroll runs ahead of collections month after month, factoring is one of several ways to close the gap. Compare it with a line of credit and a short-term loan using your own receivables and pay schedule, and choose the structure that keeps paychecks on time at a cost your margins can carry.

Payroll factoring lets a business turn unpaid customer invoices into cash for wages, often within days of submitting them. Instead of borrowing, you sell the invoices to a factoring company at a discount and use the advance to meet payroll.

It suits companies that bill other businesses or government agencies on net terms and pay their own workers every week or two. Below is how the process works, a worked example of the math, and how it compares with a loan.

How Payroll Factoring Works, Step by Step

1. Invoice. You complete the work and bill your customer on your normal terms, such as net 30 or net 45.

2. Submit. You send the invoice to the factor with proof of delivery, such as signed timesheets or a completion report.

3. Verify. The factor confirms the invoice, often by checking with your customer that the work was done and the amount is owed.

4. Advance. The factor sends most of the invoice value to your bank account, and you use it to run payroll.

5. Collect. Your customer pays the factor on the due date, usually to a lockbox or account the factor controls.

6. Rebate. The factor releases the reserve, which is the remaining balance minus its fee.

A Worked Example

The numbers below are hypothetical and chosen to keep the arithmetic easy to follow. Real advance rates and fees vary by provider and by the credit of your customers.

• Invoice amount: $40,000, due in 30 days

• Advance rate: 90%, so the factor sends $36,000 right away

• Reserve: the remaining $4,000, held until your customer pays

• Fee: 2% for the first 30 days, plus 1% for each additional 15 days or part of 15 days

Your customer pays on day 42. That is 12 days past the first 30, so one extra 1% period applies. The total fee is 3% of $40,000, or $1,200. The factor releases $4,000 minus $1,200, which is $2,800.

In total you receive $38,800 for a $40,000 invoice: $36,000 when payroll was due and $2,800 about six weeks later. Had the customer paid by day 30, the fee would have been $800 and the rebate $3,200.

Keep in mind that the fee is charged on the full invoice even though only 90% was advanced. Measured against the cash you actually received, the effective cost is a bit higher than the stated percentage.

Recourse and Non-Recourse Agreements

The agreement decides who absorbs the loss if a customer never pays.

• Recourse. If an invoice stays unpaid past a set period, you must buy it back, replace it with another invoice or let the factor deduct it from future advances. Fees tend to be lower because you keep the credit risk.

• Non-recourse. The factor absorbs the loss if a customer cannot pay because of insolvency, within limits stated in the contract. Fees tend to be higher, and the protection usually does not cover disputes over your work.

Read the definition of a covered credit event closely. Non-recourse protection is often narrower than owners expect.

What Your Customers See

In most arrangements, the factor sends your customer a notice of assignment asking it to pay the factor. Under the Uniform Commercial Code, once a customer receives proper notice, paying you instead may not discharge its debt, so customers generally follow the new instructions. The factor also files a UCC financing statement to record its interest in your receivables.

For large customers, a change in remittance address is routine paperwork. Still, ask to see the notice letter and how collection calls are handled before you sign, since the factor will be dealing with people you want to keep as customers.