Question


Alby

Borrowing Money for Payroll? Why?

Recently the news has been talking about the failure in the credit markets and how businesses can't loans to meet payroll. Could somebody tell me why in the world would a business get a loan to meet payroll? Is this a tactic taught in Business School? Why is paying employees with borrowed money better than paying them with money from product sales?

1 year ago - 2 answers

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In many cases, businesses, although profitable, face cash flow shortages. Let's say you have 10 employees and for the month, they get paid a total of $1,000 each in two payments of $500 each (say on the 15th and 30th). So your payroll is $5,000 and $5,000 for $10,000. Now, make believe that you produce something you can sell for $20,000 and it costs you $6,000 in raw materials to make. Between payroll and raw materials, your costs are a total of $16,000, so you have a profit of $4,000 - theoretically, you should be doing good. Now lets say you sold 1/2 of the goods on the first and 1/2 on the 16th - that's $10,000 in sales for $8,000 in outgo - you certainly should make payroll...except you sold 1/2 of those goods on 30 days same as cash, so your cash sales were only $5,000, you still had to pay $3,000 for the raw materials, leaving you $2,000 for a $5,000 payroll...you need a bridge loan of $3,000 to make payroll, even though you are a profitable company - even if you paid 30 days same as cash for teh raw materials, you would still only have $3,500 on hand for payroll. So, this is not a tactic taught in B-school, it is just the normal rhythms of business (and is even worse if you need to run an inventory of raw materials).

by Steve D

1 year ago

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Other Answers

I am guessing that you know the answer. As your questions are spot on. That is indeed a serious problem and not recommended in business school. However, I could see this being necessary if you were just starting out and growing - you need to pay company taxes, insurance, and labor cost. That begs the question though why would you be growing your new business if the revenue didn't support it? I think these people are getting what they deserve as mean as it sounds. It is time to weed out the weak. The people that should NOT be running companies. I look forward to my competition being eliminated and my company being rewarded for maintaining a positive cash flow and saving funds instead of continuing to borrow.

by Justin F- 1 year ago

In businesses where they bill on a monthly cycle, some need to borrow money to hold them over until payments are received. These companies do not always have large amounts of money saved to carry them through the mid-month pay day. Also, they may have to borrow in times of slow or seasonal sale slumps.

by Paul M- 1 year ago