Accounts Payables & Receivables Reviewed for Payroll Funding
Steve Capper/Flexible Funding - August 19, 2020
There are usually two reasons for contacting a payroll funding company. The first is sales or billing growth and the second is some level of financial strain not directly related to sales. An example of financial stress is when the accounts receivables of the business do not flow well enough to meet the business payables. If your company were to go under because you cannot meet payables there would be a big mess for the funding company to clean up. Therefore, when a funding looks at funding your invoices they will sometimes scrutinize payables as well as receivables.
Any business may have payable liabilities for labor, taxes, expenses, or notes payables. 'Accounts Payables' may be categorized as 'trade payables' for the expensed purchases of advertising, travel, office supplies, utilities, entertainment, etc. (Notes payables are separate debts created by formal legal instrument documents...which will not be examined in this discussion.)
In a traditional staffing company, payroll for labor may be viewed as a very short term liability payable; payroll is made weekly or bi-weekly. Using this week's incoming cash flow to make this week's payroll liability is a good sign-- that of an average healthy business. Fast, large, and frequent need for funding advances days later in the following week-- to cover payroll for the prior week -- is a sign of financial stress. The financial stress is obvious to a funding company should they observe (or be informed) that a staffing company has a negative bank balance on a given day. If a staffing company doesn't have enough money for temp hours worked and must stall payroll a few extra days to bill (and fund) more new invoices, the business could be in big trouble if billings drop and payroll cannot be covered. In the course of due diligence with prospects, payroll taxes and back payroll issues may be examined closely by a funding company including an examination of quarterly 'signed' payroll tax returns, bank statements, and clearing of checks. A funding company could probe into any disputes with third party payroll services or any of their weekly or biweekly payroll reports. And a funding company might actually call the tax service--in a conference call with the staffing company owner--or request other written verifications directly from the tax service.
A second form of temp payroll is with independent temporary workers. IT information technology, engineering and other professionals often work through staffing or consulting companies doing hourly or project work. These professionals may organize themselves as corporations...so that their 'corporations' are performing labor for other businesses (who are also organized as corporations.) The staffing or consulting companies are just hooking up, or brokering, the corporations that need labor with the corporations that can provide labor. This is referred to as corp-to-corp billings. The individuals (organized as entities-corporations) providing labor may be paid a month later after services have been performed, and until then remain on the books of the staffing or consulting company as an accounts payable liability. These payables would be examined to be sure that the receivables flow and conservative levels of funding provided by the funding company can meet those payables on time.
Free Financing in Accounts Payable
Accounts payable are amounts owed to suppliers of goods and services from whom the business has bought items on credit, allowing them to pay for goods or services after it has already been supplied. Payables are often categorized as 'trade payables' ...payables for the purchase of goods or services that are expensed such as advertising, travel, entertainment, office supplies, utilities, accounting, web software rental, employee screening, some insurances, etc.. This may include capital equipment purchased on credit for which payment is expected in less than one year.
In any business, growth is financed by invested equity-capital of the owner and by retention of profitability in the business plowed back into the company. A bank, ABL- asset based lender, payroll funding company, or factor may also finance the assets of a business until cash comes in. The third leg of financing is provided by trade vendors and should be recognized as 'free' financing to the extent that you do not have pay any interest when and until the bill is paid, or do not have to borrow the same amount from somewhere else at a cost. This free financing may be managed and maximized for benefit. However, it must be determined how much room there is to lean on the trade before considered delinquent, requiring some payment on past due balances.
Any funding company may look for warning signs and symptoms of accounts payable problems including:
- Lots of bills being paid an average of 45 to 60 days late, or later
- Interest charges and/or penalties on 'overdue bills'
- Disorganization..such as unpaid bills getting thrown into someones desk instead of getting entered into the A/P accounting system that will track their payment
- Overdue taxes
- Creditor pressures
Accounts payable should be actively planned and bill payment may be manipulated in response to market factors like a sales decrease or slowdown of collections. It makes sense that if it took 90 days to collect your receivables, it would be economically destructive to continuously pay your bills within 15 days. Payment priorities should be set up with top tier payments that are paid at all costs and according to the terms agreed upon. This would include federal and state tax obligations, bankers, rent, and any major vendor and service suppliers. This first group would be obligations that are to be paid as soon as they're due. Some people date checks no earlier than the dates upon which payments are due and see to it that suppliers should receive checks no more than a day or two earlier than the due date. The second tier of payment priorities may include those which offer more room for short term maneuvering during cash flow crunches, such as minor suppliers. The second group usually includes bills to be paid within 15 days including amounts owed to professional contractors for services already performed. Second tier vendors or suppliers may be more flexible and understanding because they need your business. A third group should be paid within 30 days....which sometimes can be stretched to the 45 to 60 day window during times of financial stress.
Funding Company Scrutinization of Payables Schedules
It is crucial to keep good payables records which should include weekly or monthly updates about the aging of every outstanding bill, including documentation that matches each bill paid. An A/P or accounts payable aging report shows each supplier name, concentration level as a percentage of total payables, total amount out with each vendor, days outstanding (or days outstanding 'period' such as1-30 days, 31-60 days or over 60 days past due that a payable may fall into) and the terms allowed by each vendor. These figures might be compared with the payables information from a year or quarter earlier, and the reason(s) for any significant changes may be ascertained. They may be due to any number of things including receivables turnover slowing down or a change of terms by the vendors as the company faced financial stress. If there are too many past due accounts, it is obvious that you are leaning too heavy on trade credit and should manage your cash better.
A payroll funding company will check to see if any of the names listed on the accounts payable aging are any of the same names that appear on the accounts receivable aging. In these cases, there may be a reserve imposed against the receivables, or such accounts may be classified as ineligible receivables for funding because they may pose a difficulty to collect.
Analyzing Accounts Payable Agings for Funding Purposes
There are financial ratios that a funding company may watch to help ensure that a funding customer has the wherewithal to pay it's bills. Balance sheet ratios (the relationship between two numbers) may be used to examine the health of your business over time, and to evaluate how a company is performing compared to other companies in the same industry. Industry trade associations publish industry average ratios based on the data supplied by it's members. Several months or years ratios may be compared to determine if any trends are developing.
One of these ratios is the accounts receivable to accounts payable ratio which it is easy to calculate; divide the accounts receivable by the accounts payable. If the receivable days are constant (and not increasing), an increasing ratio means that profitability is increasing. If receivable days are constant, a decreasing accounts receivable ratio may mean that profitability is decreasing. If receivable days are increasing or decreasing, it is obvious that you have a worsening collection problem or that your collection problems are getting better.
The 'average payable period' is indicator of how well a company is managing its cash outflows. It measures the average amount of time a company uses each dollar of its trade credit before paying its obligations. The formula for calculating average payable period is dividing the account payable balance by your average daily purchases on account. The average daily purchases on account figure for the bottom denominator is found by dividing total purchases for the period divided by the number of days in the period. If you were analyzing it on a 'quarterly' basis for example, the account payable balance would be the balance at the end of the quarter. The total purchases would be the purchases for the quarter, and the number of days in the period would be 90. On a 'monthly' basis, the end-of-month figures would be used and the number of days would be 30. When you maximize trade credit and delay cash outflows, there will be a longer average payable period. To the extent that trade credit is used one gets interest free financing that can be used for making other necessary purchases
Another ratio that may be compared from one period to the next--looking for trends-- is the 'accounts payable turnover ratio' which measures the speed with which a company is paying it's suppliers. As this ratio declines, it can indicate that a company is paying its suppliers more slowly. The ratio is found when you divide supplier purchases (purchases on terms, not CODs) by the average amount of accounts payables. To find the average amount of accounts payables (denominator) for the above ratio calculation, add the payables amount at the beginning of the measurement period to the payables amount at the end of the period and divide by two.
Once you have the accounts payable turnover ratio number, you can find the average number of 'days' that bills remain unpaid by taking 365 days and dividing it by the ratio number.
Manage your payables consistently, but always stay on top of receivables; both receivables collections and accounts payable must be worked because unpaid invoices won't pay the bills.
We often see trouble develop when business owners wear too many hats and only do collections work or payables management when things get out of control. If the owner of a business cannot do it on a continuing basis, then they should hire a competent accountant or bookkeeper on a contract basis to collect. Any good business owner understands that sales are not the only determinant of profitability.