What is Payroll Factoring? Get Your Team Paid Faster

It is common for small business owners to treat their teams as family. However, those who don't understand what payroll factoring is may find that late salary payments prompt those "family members" to log on to Indeed.com behind their backs.

Many business owners struggle to maintain a consistent payroll. Although retaining talented workers is crucial to their success, it can be difficult for small-and-medium businesses (SMBs) to meet salary obligations on time.

Payroll factoring is a flexible solution to address such issues and keep everyone happy.

This is particularly true for SMBs who depend on receivable accounts. According to the World Bank, most buyers demand 30 to 90 days to pay sellers upon receiving an invoice. These invoices might form a financial burden when clients pay later than this..

Payroll factoring helps businesses by closing the financing gap between getting paid and paying their dues. It stands as an ideal choice for small businesses and startups denied from small business funding options like long-term loans.

This article will help you understand what payroll factoring is, how it operates, its benefits, and how to acquire it. We’ll cover the following:

  • What is payroll factoring?
  • What is the difference between payroll factoring and payroll funding?
  • What types of payroll factoring are there?
  • Why use payroll factoring services?
  • How does payroll factoring work?
  • What to look for in a factoring payroll services provider?

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What is payroll factoring?

The time it takes for a company to get paid after invoicing a client might take weeks, or months in some cases. Payroll factoring is an immediate way to convert future revenue into usable funds by cashing out invoices in advance.

In payroll factoring, businesses can receive an instant cash advance of around 95% of their receivable invoices by selling them to a payroll factoring service provider at a pre-set discount rate.

Clients pay the payroll factoring service provider the invoice amount instead of paying the company. According to Forbes Financial Advisor, factoring fees range from 0.5% to 5% per month.

what is payroll factoring

What is the difference between payroll factoring and payroll funding?

When Googling the term ‘what is payroll factoring?’, the word “payroll funding company” may also come up. Both services help businesses when invoices are used to ensure a cash flow. Still, they are fundamentally different solutions, so it’s important to learn about both before deciding.

Payroll factoring is not a loan but rather the sale of accounts receivable to a factor, who, in exchange for an upfront fee, will collect invoices from customers and fully control the receivable accounts.

Payroll funding, or payroll financing, is a type of business funding typically processed online in a matter of hours and uses the borrower’s invoices as collateral. In addition, the business will control its interactions with the clients and be able to pay back the loan as soon as the overdue invoices are settled.

What types of payroll factoring are there?

We can break payroll factoring services down into the following types depending on the service scale and the responsible party.

Payroll factoring service types depending on the scale

Companies that handle payroll may also offer a “money service,” in which they supply the necessary funds to the client. This business also handles payroll tasks, including processing paychecks and filing payroll taxes. Some factoring companies offer comprehensive services in which they control everything.

Payroll factoring service types depending on the responsible person

There are two primary categories of payroll factoring services when it comes to responsibility: recourse payroll factoring and non-recourse payroll factoring. These differ according to who is held liable for outstanding invoices.

Recourse payroll factoring

The client assumes all risks and is still responsible for unpaid invoices.

Non-recourse payroll factoring

The factoring company assumes all risk and has no recourse to the client for unpaid invoices.

Why use payroll factoring services?

Staffing agencies, SMBs, and new ventures can all benefit from working with payroll factoring services:

  1. Fast cash flow allows for staff payments, business expansions, and acquiring new customers. In this sense, payroll factoring works as a business loan alternative to traditional lenders.
  2. Small businesses can’t afford to wait 30 to 90 days for payment and need to get paid weekly. Payroll factoring provides this.
  3. There is no need for collateral or to give up a company's equity to gain access to factoring services. It only requires having receivable accounts with creditworthy clients.
  4. With plans starting at just six months, payroll factoring services are ideal for businesses needing a quick fix.
  5. Payroll factoring services can help any firm, including new ventures, that may have trouble getting traditional loans or finance.
  6. Payroll factoring services make it easy for companies to keep their valuable employees after an exhausting recruiting process.

How does payroll factoring work?

Even though there are numerous companies offering payroll factoring services, the fundamental steps remain the same.

Here’s how a small business’s payroll factoring process might look.

  1. Finding and selecting a reliable payroll factoring company

When starting out, a small business should research payroll factoring service providers thoroughly and make a list of their features and factoring fees. A detailed list makes assessing options easier and more efficient, and improves their chances of choosing the best one.

  1. Getting approved by the factor

The factoring company may check the company’s operational status, invoices, and line of credit history. When the review period is through, the payroll factoring firm will provide the business with a contract including all the payment terms, fees, payment plan, and conditions, as well as the maximum funding amount available.

  1. Accepting the agreement and receiving the advance rate

After signing the agreement, the factoring company will advance the client an amount of money, often known as the advance rate, equivalent to 80%-90% of the invoice value. This money can be received via wire transfer or check.

On top of that, the factoring firm will advise the client that the factoring firm, not the client, is responsible for collecting payment.

  1. Receiving the reverse amount

As soon as customers pay the invoices, the business will receive the remaining sum, often known as the reverse amount. The payroll factoring services provider will remove a service fee (or rebate) from the payment before sending it to the business.

What to look for in a factoring payroll services provider?

For the business’s financial operations to run smoothly and efficiently, choosing the best factoring payroll services provider is essential.

Industry related experience

Ideally, the payroll factoring firm would be based in the same field as the business. Its intuitive understanding of the business model will save time and make the process more reliable, especially for those running a staffing agency with a consistent payroll system.

Contract flexibility

A signed agreement will govern the relationship between the company and the payroll factoring services provider. As such, the contract terms are crucial in this relationship, and more flexible factoring terms will be good for long-term cooperation.

Customer service

Because the factoring company and the SMB will need to have a close working relationship and open communication lines, customer service is important in ensuring satisfaction.

Fast response times are crucial in maintaining good communication, and some factoring organizations provide dedicated account managers for each client or client group. Reviewing the company’s website and social media platforms is useful for gauging the quality of its customer service.

Factoring rates

The factoring company will typically purchase invoices at a discount, and this discount will serve as the basis for the general charge. Lien filing and background check expenses are just two examples of the additional costs that should be identified and understood before signing any contracts.

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  • Businesses, particularly small ones, often find themselves in a position where they need more funding.
  • Payroll is a complex and time-consuming aspect of running any business.
  • Using payroll factoring services ensures reliable payroll processing.
  • Payroll factoring services are a simple way to provide immediate cash in exchange for accounts receivable from customers.
  • Payroll factoring makes it possible to get funding quickly without giving up equity or submitting collaterals.

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