When does it make sense to borrow money to cover payroll?

2 MIN. READ

Ideally, payroll should represent between 20-30 percent of your business’ expenses. Balancing your expenses and cash flow requires a lot of careful planning, but there are situations where planning won’t be sufficient.

Covering payroll, payroll taxes and benefits paid to employees can become a challenge if you run into cash flow disruptions or delays. Under the Fair Labor Standards Act, you are obligated to compensate employees promptly. Pushing back payday can have disastrous consequences on a business, including crushing morale. Employees will start seeking other opportunities if you are unable to compensate them.

You can maintain confidence in your business’ leadership and morale by borrowing money to cover payroll. There are different options to consider, including using a credit line, borrowing against future sales and borrowing against accounts receivable.

Here are a few examples of situations where you should consider borrowing to cover payroll expenses.

Disaster scenarios

A new recession or economic crisis can cause your sales and revenues to come to a standstill. A news story or new policy that impacts your industry can have severe consequences on your revenues as well.

Likewise, a natural disaster can completely disrupt your business. Your client base might not be in a position to make purchases or the aftermath of the disaster might prevent your business from operating as usual.

Those are scenarios where financing payroll by borrowing means that employees will stick around and can still support their families while you focus on creating a plan to get back on your feet.

Planned and unplanned expenses

Businesses sometimes incur major expenses that weren’t planned. Here are a few examples:

  • A major piece of equipment breaks and needs to be replaced or repaired
  • There is an urgent need to upgrade equipment for safety reasons
  • You need to purchase a software upgrade to meet new compliance requirements
  • You receive a large order or see a sudden surge in sales and need to spend more on inventory
  • You need to cover costs associated with hiring specialized talent or with hiring several seasonal employees

In those scenarios, an immediate expense reduces your cash flow but results in growth. Borrowing to cover payroll helps balance your finances and frees up cash for necessary expenses.

Cash flow delays and disruptions

Losing a major client or having a client cancel a large order is going to impact your revenues. You might also encounter difficulties with collecting some accounts, whether you deal with delays or failure to collect.

Issues with accounts receivable or clients can temporarily freeze your cash flow. Borrowing will help you cover immediate expenses like payroll and give you time to bounce back and find new clients.

Covering payroll should be a priority, but there are different unexpected situations that can reduce your cash flow. If you find yourself unable to cover payroll, assess your situation and compare financing options to find one that makes sense for you.

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