Payroll Funding Math & Calculations - Determining the Real Cost

Funding organizations don’t always address in their payroll funding agreement how they handle check clearance and posting, and it certainly affects the ultimate rate you pay. You must ask for the details.

If a payroll funding company waits 5 days to clear or post out-of-state checks, you must add that into the rate and determine ultimate cost to you. You start with 5 days for clearance. Be sure to add in the two days of the weekend. Now you have 7 days of float.

Seven days out of the month (30 days), means 7 divided by 30 which = 23%. The math result means that the payroll funding company or bank is delaying 23% of your cash collections during the month. When they delay you don’t have access to that cash, which means that you have to borrow that same amount back from the payroll funding company or bank "weekly" in order to run your business. This means more fees. More total fees in a period of one year means higher annual rate and cost.

The payroll funding math is simple but eludes many shoppers. Most likely this 23% higher cost of funds borrowed was not on the proposal or term sheet that the payroll funding company or bank salesperson first presented to you when they were trying to sign you up. It is not always covered in the legal/loan documents, services agreement, or weekly funding and profit reports they propose to provide you.

Payroll funding companies that are owned by banks, recently purchased by banks, previously owned by banks, and banks are more likely to have clearing floats (than privately-held payroll funding organizations).

Payroll Funding Companies

A payroll funding company may not call their clearance days "check clearance". See if they use another name for it. They may say that they "clear checks" every day, however, they may not apply the full amount to your receivables balance, or your loan balance. Find out if they apply all "partial" customer payments daily. If they don’t apply partial customer payments to your loan, they are keeping your loan balance artificially higher. And of course, the partial payments sitting in the factoring or funding company’s bank account will be earning them interest all year long.

There are other ways that payroll factoring or payroll factoring companies may obtain additional unstated rate or cost that you should be aware of. In a billing/invoicing and pay/collection cycle there is a "front end" and a "back end." The front end is when you do your invoicing or billing for your staffing agency. The back end is when your customer pays the invoice. The check clearing period discussed earlier is an example of a back-end payroll funding or lending float/delay – it happens when the check is paid.

A front-end lending float can also cost you extra. On a certain day of the week the temp agency will do invoicing. For example, invoicing could be done on February 1st , and the date marked on the invoices will be February 1st. Many lending organizations, especially factoring companies, require that you first send the invoices to the factoring company. (You cannot mail the invoices to your customers directly.) If you produce your invoices and overnight them to the factor or lender you have already lost one day (as invoices are not yet at your customer’s office on the 1st). They arrive at the factor/lender on February 2nd.

Other Costs of Payroll Factoring

The factoring company may then take one or two days to enter them into their software systems, stamp them with a stamp that informs your customer of the invoice sale, and prepare the stamped invoices for mailing or overnight express. Now it is February 3rd (or 4th). Once the invoices are sent out by the factor it can then take another day if over nighted (or more days if mailed) for your customer to receive them. At best, the invoices arrive at your customer on February 4th.

The factoring/funding company may have been charging you an expensive fee or interest rate starting February 1st for the use of the money they have lent you. Your customer has not seen the invoices for days and do not even have it in their payment processing system and cycle. This is an example of a front-end float.

If a customer normally processes or pays all invoices 28 days after they receive them, they will now be effectively paying or processing them in 32 days (28 days + 4 days). Unfortunately, with many funding companies the rate structure increases into the next rate category as soon as the invoice goes over day 30.