What Is a Payroll Loan and How Does It Work for Small Businesses?

Running a small business comes with myriad challenges, and although businesses have seen upticks in earnings, revenues and expenses remain high. From onboarding new employees to providing health insurance for them to finding the best suppliers, there are constant challenges that can stress your working capital and create cash flow gaps. One of the most significant, however, is payroll for small businesses.

While payroll software can simplify direct deposits, tax filing, and payroll processing each pay period, it doesn’t put more money into your business. In fact, it’s quite the opposite. Even the most affordable payroll services for small business may add to the strain on your finances. When your payroll for small business is straining your cash flow, a payroll loan can be a lifeline to cover the gaps and ensure your employees are paid on time.

What Is a Payroll Loan?

A payroll loan isn’t a specific type of loan. Rather, it refers to how you use the money. It’s a short-term financing option to cover payroll for small business, which may include salaries, hourly wages, commissions, bonuses, garnishments, payroll taxes, and employee benefits. A payroll provider helps streamline time tracking, bookkeeping, and can even file taxes, but it doesn’t inject capital into your business. Small business owners still need to pay out of their business bank account.

When you’re unable to meet payroll costs, you can leverage a payroll loan to run easy payroll for small businesses. Typically, the bank provides the upfront financing, and then you can use your payroll system to run payments like normal, making it an easy payroll for your small business. While these loans can ensure that your employees are paid on time, keeping them happy and motivated, it’s important to take steps to avoid making this a habit.

When Does a Business Need a Payroll Loan?

You have a legal obligation to pay your employees on time and in the right amount. Small business payroll can be challenging, given tax calculations, connecting to your accounting software, administering health benefits, and dealing with unique situations like workers’ compensation, but that doesn’t mean you don’t have to do it. The top payroll companies for small business offer all-in-one solutions that make it easier to do payroll and process pay stubs, but the financial stresses of business can put your automated payroll in a crunch.

Basically, any time you don’t have the cash to meet payroll for your small business, you may want to consider a payroll loan. Some situations that may disrupt cash flow include:

• Payment delays from customers
• Encountering unexpected or emergency expenses
• A reduction in seasonal revenue
• Holding too much inventory
• Natural disasters or other disruptions to business

Startups and established businesses alike may experience cash flow gaps, but payroll for small business is absolutely crucial. Getting a payroll loan can help ensure you meet local tax and federal tax obligations while gaining the peace of mind that your employees get their paychecks on time.

Types of Payroll Loans

Many lenders won’t advertise “payroll loans” because many loan products may serve as this type of loan. Traditional banks and credit unions may offer short-term business loans or lines of credit that you can leverage as payroll loans. Online lenders might have fast-funding solutions available within a few business days, although usually at the cost of higher interest rates.

Working capital loans

Essentially short-term loans, working capital loans provide you with a one-time, lump sum of money that you can use to run a full-service payroll, contribute to employee retirement plans, buy inventory, or meet any other business need. These loans typically have repayment periods of between six and 24 months and may have higher interest rates than longer loans.

Each lender has different eligibility requirements and loan terms, so you may have to make weekly or monthly payments, but they’re a convenient way to meet payroll for small businesses.

SBA loans

The United States Small Business Administration (SBA) works with lenders to partially guarantee loans, reducing the risk of default on both the borrower and the lender. The SBA has several options to help payroll for small businesses, including the popular SBA 7(a) program and SBA Express Loan program. You can’t use these loans to pay delinquent payroll taxes that you owe the IRS or state tax authority, but they can help you out of a pinch when you’re short on cash to run payroll for your small business.

Business line of credit

A business line of credit gives you access to a maximum loan amount that you can draw on when you’re short on cash flow. For instance, if you have a big workers’ comp claim, are at risk of falling out of tax compliance, or may miss a payroll run, you can draw on a line of credit to get the cash you need to meet your financial obligations. Rather than pay interest on the whole loan amount, you only pay on what you withdraw. With a revolving line of credit, when you pay back what you’ve borrowed, you’ll have access to the full loan amount again.

Invoice factoring

Invoice factoring can be one of the fastest solutions when you’re at risk of missing payroll for your small business. This alternative form of funding sells your invoices at a discount to a factoring company, which then assumes the responsibility of collecting the invoice. If you have a lot of customers who are delayed in payment, this can be a good way to turn those outstanding balances into upfront cash. The best online payroll for small businesses, like Gusto and Paychex, allow you to get very close to the payroll run date before processing payment, so invoice factoring can be a good last-minute solution if you’re short on cash.

How to Avoid Payroll Loans

Payroll for small businesses is one of the most important expenses, and one that you may face legal penalties for missing. But payroll loans can also be costly, especially if you’re dealing with a cash flow crunch. It’s best to manage your business finances to avoid needing payroll loans in the first place. Some ways to do that may include:

• Conduct frequent business cash flow analysis to time your fixed and variable expenses.
• Leverage forecasting tools in accounting software like Quickbooks Online.
• Maintain cash reserves to pay for emergency expenses.
• Utilize automatic billing options and request immediate payment terms from customers.
• Use a business credit card to cover short-term, recurring expenses.
• Leverage outsourcing resources to reduce benefits administration needs and payroll costs.
• Use HR tools to file tax forms on time and avoid penalties. (Even affordable payroll services for small businesses can usually offer this.)
• Don’t pay bills until you have to, unless there’s a clear incentive to do so.
• Reduce expenses or raise your prices to increase margins.
• Eliminate products and services that aren’t making any money for your business.

You should avoid serious measures like reducing employee PTO or benefits as these can have serious impacts on morale and productivity. The goal is to keep running payroll for your small business, not cut it entirely.

Final Thoughts

Payroll for small businesses can be a challenge. While there are many payroll solutions with payroll features to make the operational side easier, cash flow challenges can make it difficult to meet your financial obligations. A payroll loan can help you meet those obligations and keep your employees paid and motivated, but these loans come at a cost. It’s best to avoid needing short-term, high-interest funding solutions, but if you need a payroll loan, you might consider addressing other business needs with the funds, as well.

FAQs on Payroll for Small Businesses

What is payroll?

Payroll for small businesses is the process of paying employees, including calculating wages, withholding taxes and deductions, and distributing payments. It also involves tracking employee work hours, managing benefits, and complying with various tax laws and labor regulations.

Can payroll loans be used for other expenses?

There is no type of loan that is specifically designed for payroll. Instead, you use business financing like a term loan or line of credit to cover payroll for small businesses. While loans like equipment financing or commercial real estate loans must be used for a specific asset, you can generally use payroll loans for a wide range of business expenses, including payroll.

What are the typical costs associated with a payroll loan?

Any short-term loan typically has higher costs than longer-term ones. They usually have higher annual percentage rates (APRs), may have significant fees, and could negatively impact your credit score. There’s also the risk of a debt trap if you’re unable to repay the loan on your next payday, incurring more fees and creating a debt cycle that becomes difficult to escape.

What types of loans could be payroll loans?

You can use a variety of loans to cover payroll for your small business. Essentially, any loan that isn’t tied to a specific asset can be used to cover payroll expenses.

What payroll taxes do small businesses pay?

Small businesses must pay several payroll taxes, including FICA Taxes (Social Security and Medicare), Federal Unemployment Tax (FUTA), and state and local taxes.

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