Find out why – and when – payroll loans might be an ideal tool to consider when you need additional working capital to ensure a payroll cycle can be funded.
What is a payroll loan?
Payroll loans are short-term loans designed for a very specific purpose: Ensuring a business has adequate cash on hand to cover the cost of an employee payroll cycle. Because they are meant to be used for such a specific purpose and may entail a comparatively high percentage rate (as much as 15 percent APR or higher), they’re heavily regulated by the government and intended for use only when your business will be able to repay it quickly.
Failure to repay a payroll loan within the specified time period (usually by the date of your next payroll cycle, which will depend on your payroll frequency) may mean your company incurs additional fees, so it’s important to use this type of financing for its intended purpose. Repayment considerations are very important when using this type of financing to fund a payroll cycle. Here are some of the scenarios when payroll loans might be most appropriate for your business.
When are payroll loans right for your business?
1. Unexpected and temporary cash flow shortage
Equipment breaks, or fails altogether. Vehicles crash. Facilities need repairs. Natural disasters strike. There are simply some things in business that cannot be foreseen, and some can deplete cash reserves significantly and without warning. Payroll loans might be an ideal way to ensure you meet payroll when cash reserves are depleted unexpectedly but a quick cash flow recovery is expected.
2. Pre-season build up
If your business doesn’t operate year-round or it has a distinct busy season, you may expend a significant amount of resources in the weeks that immediately precede the rush. For example, the tax preparation industry does the bulk of its busy season accounting tasks from January to April. Other examples include retailers, resorts, and recreation businesses which are only open during summer months, schools, tutoring services and other education-related organizations, skiing, snowboarding and other cold-winter-dependent facilities, and so on.
If your business needs to add and train staff prior to its busy season, the preseason cost to train and onboard new employees in addition to the first payroll cycle in the new season might find you temporarily short of cash reserves. Payroll loans can help you preserve working capital needed for other expenses until your busy season. Busy season sales and cash flow will quickly and easily cover the cost of repayment.
3. Fast growth
If your company is growing quickly and you need to hire and train a significant number of new staff members in order to ensure demand and customer service needs can be met, you might find that you need funding to cover the first payroll cycle while sales are still heating up.
4. Cyclical lull
Similar to busy seasons, cash flow lulls can be a normal part of business for some companies, such as when there’s a gap between a big sales period and the time you receive customer payments on accounts receivable payments. Since receipts needed for repayment will be coming in over the short term, payroll loans might be an appropriate financing tool to bridge the gap.
If you decide to use this type of financing, make sure you have a solid projected cash flow showing you will be able to repay the amount within the designated time period.
If you are unsure or question whether you can repay the amount fast enough, you can also consider other alternatives. Alternative options could include business advances or a line of credit that will help ensure you have the working capital you need to fund payroll, but have more flexible repayment options.
Like any other business finance tool, payroll loans have characteristics that might make them more or less appropriate for use in some situations than others. This type of financing is most ideally suited to otherwise financially healthy companies that reasonably expect to be able to repay the amount within a short time period, which may be as little as a couple of weeks up to a few months.
As a business owner, understanding the working capital resources available to your business before you need them is vital, so that when a need arises, you know which financing tool is most appropriate for use in a given instance, so that you can keep your business healthy and growing.
This article is a guest article contributed by Kabbage.