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Payroll Funding Can Solve Short Term Cash Flow Problems

By William R. Robins, principal in Payroll Funding, LLC

Two years ago probably all sweeping companies had adequate capital, meaning that they had an adequate cash flow. Today, customers are paying their receivables much slower than before, so the company that was adequately capitalized two years ago now finds itself undercapitalized.

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Since the recession began – over a timespan that is now going on two years – the banks have stopped lending and the stock market has taken a hit. The latter destroyed private investment, reducing drastically the availability of private capital.

We find three types of this undercapitalization problem. The first is liquidity, where the client is paid in large, lumpy amounts. In this type of situation, if a holiday or snowstorm or some random thing happens he doesn't collect enough money to pay his payroll, rent or other bills that cannot be deferred.

The second type of problem is that the client has a permanent capital problem – the company is always short of cash. Although perhaps not for payroll, because it has a high priority, but this type of company consistently has trouble paying its bills timely. Firms in this situation probably have to ride their payables pretty hard, and this forces the management team to spend a lot of time managing cash flow rather than working for profit and/or growth.

The third type of undercapitalization is where a client lacks the capital to expand. The economy seems to be reviving now and many companies would like to add a salesman or grow in other ways. The problem here is that it typically takes six months for a salesman (or any other investment) to generate cash.

Of course, in large part a company does not actually need capital – it simply pays its own payables as it collects its receivables. The problem is payroll. Payroll is large (typically 45% of sales) and cannot be deferred. So, if more than 45% of receivables start paying slower than normal a sweeping contractor runs the risk of not making payroll.

This type of situation causes management to spend a good deal of time trying to delay payment of bills and accelerate payment of receivables. For the most part, this is something that ties up top management because clerks cannot get through to the decision makers. Nor are they particularly adept at this sort of thing. So, top management's time and effort is diverted away from growing the business and managing for long-term profit to simply working on daily cash flow problems.

A case can be made that capital – and therefore payroll – is a marketing question, not a financial one. With capital, a sweeping contractor can bid for jobs knowing that he can pay the payroll on those jobs every week – and yet wait 60 days to collect the receivable.

Example: an Angel leaves $45 under the contractor's pillow one night. The sweeping contractor then takes a one-time sweeping job for $100 that will produce a $10 profit. To do it, he pays payroll of $45 in cash. Then, 60 days later he collects $100 and pays out $45 in other costs.

His return? He invested $45 and got back $55 in 60 days. If he did that every 60 days his additional $45 of capital would generate $600 in annual sales and $60 in annual profit! Just $1 of capital enables the contractor to increase sales by $12 and produces return on investment of 133%. Now, there's an angel for you.

There is also a marketing/competitive aspect here: In today's market his competition might not be able to bid for that job because they don't have the capital that lets them wait 60 days to get paid. So, his company's marketing is improved. Not to mention pricing... If the competition cannot bid for lack of capital obviously he will charge $105, not $100, for the job. That's why having capital is both a marketing and a financial consideration.

So what can a sweeping contractor do? The trick is to borrow funds to pay payroll and then repay that debt over a 6-month-to-1-year period. For instance, if payroll is $40,000 then the company would borrow that amount instead of paying the payroll. This gives it a large, meaningful chunk of money to invest and spend. And, since repayment can be spread over the next 6 months in weekly installments each single installment will be so small that it can be handled out of normal cash flow.

The net result? At the end of 6 months the company has $40,000 in cash it did not have before and no debt. In the worst case the company would pay that $40,000 loan out of the profit on whatever the $40,000 was invested in.

The problem, of course, is that a contractor's normal financing sources focus on equipment lending and leasing, not working capital. And banks, which normally provide working capital, aren't lending. Even if they were, many owners of sweeping companies have credit scores that are too low to qualify for working capital loans because they have personally guaranteed so much equipment debt.

This is the conundrum: The decline in the stock market has wiped out investment portfolios of families and friends to the point where little-to-no equity is available for smaller companies. The fiscal crisis keeps banks from lending, low credit scores keep smaller companies from borrowing on credit cards or from consumer lenders, and the low real estate market has largely removed mortgages on homes as a source of cash.

Payroll funding solves these problems. The payroll funder pays the payroll and then the client repays when it is convenient, up to six months later. Payments are generally made by an ACH drawn on the client's bank account each week and are a level amount consisting of both interest and principal.

Typical cost would be 4% annual interest rate plus wire costs of the payroll, plus an additional fee and partial paydown if the payroll is deferred for an additional week. The credit limit generally runs from 2-to-4 weeks of payroll.

In most cases there is no personal guarantee so the owner's FICO score is not affected. There is generally no collateral or lien, no upfront cost, and frequently not even a written application. The reason that payroll funding does not require the safeguards typical of most lenders is that an employee leasing company generally is required to be the employer of record.

The payroll funder pays the payroll to the employee leasing company which, in turn, agrees to add the weekly installment onto the payroll invoice he renders to the client (if the payroll funder so requests). The net result is that the client cannot get his payroll paid unless he makes the weekly installment.

In short, securing adequate capital may be the prime goal of a sweeping contractor in today's economy, an economy that is turning around but in which the supply of capital is at historic lows. However, being able to expand in this market when others cannot can provide a substantial payoff: By moving quickly to take business now a sweeper will have a strong competitive position when capital becomes available to his competitors.

The author, William R. Robins, is principal in Payroll Funding, LLC, which specializes in providing payroll funding solutions to the contracting community, including sweeping contractors. You may reach William Robins via email sent to info@PayrollFundings.Com. The company's phone number is 609.924.9394.

Payroll Funding, LLC is a family trust that has a limited amount of funds available for payroll funding. These funds are allocated (1) first to existing clients and then (2) on a first come, first served basis to new clients of PEOs who have worked with PFC in the past, and (3) to new clients coming from new PEOs. Typically a client must sign up for funds two-to-three weeks in advance.

This article was added to in April, 2011.

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