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Accounts payable and accounts receivable both represent the flow of cash in a business. However, they have distinct differences. Account receivable refers to money that is due to your company but not yet paid. Accounts payable, on the other hand, is the money your business owes its suppliers and vendors for goods or services received but not yet paid for.

Maintaining a healthy balance of cash inflows and outflows is essential for the financial health and stability of a business. It also allows your company to maintain positive relationships with customers and suppliers, and can improve your chances of getting a small business loan.

Here’s a closer look at how accounts payable and accounts receivable work, their similarities and differences, plus tips on how to monitor and manage your company’s cash flow.

💡 Recommended: SBA Loan Requirements

What Is Accounts Payable?

A company’s accounts payable are amounts it owes to suppliers and other creditors for products or services purchased and invoiced for but not yet paid for.

Whenever you buy a good or service on credit (meaning you don’t pay cash up front), you have created an accounts payable. For example, if you purchase materials for $1,050 from a supplier and ask that supplier to send you an invoice rather than paying immediately, you would list that $1,050 in accounts payable.

Accounts payable does not include payroll or long-term debt, but does include payments on that long-term debt.

A company’s total accounts payable balance at a specific point in time will appear on its balance sheet under the current (or short-term) liabilities section. Accounts payable must be settled relatively quickly to avoid default.

How Accounts Payable Works

The accounts payable (AP) department is responsible for processing expense reports and invoices, and making sure all payments are made.

When the AP team receives a bill for goods or services, they need to record it as a journal entry and post it to the general ledger as an expense.

Once the expense is signed off on by the appropriate person, they will then pay the bill according to the terms of the contract, such as net-30 (within 30 days) or net-60 (within 60 days), and record it as paid. A company may choose to pay its outstanding bills as close to their due dates as possible in order to improve cash flow.

A strong AP team maintains good relationships with suppliers by keeping vendor information accurate and making sure bills are paid on time. They can also help the company save money by taking full advantage of favorable payment terms and any available discounts.

Calculating Accounts Payable

All outstanding payments due to vendors, suppliers, partners, and creditors are recorded in accounts payable. As a result, if anyone looks at the balance in accounts payable, they will see the total amount the business owes all of its vendors and short-term lenders. This total amount also appears on the balance sheet.

Pros and Cons of Accounts Payable

  Pros:

•  Keeps debts and future payments organized

•  Helps companies stay on track of outgoing money, as well as when they should spend vs. hold

•  Provides key financial information to potential investors or lenders

  Cons:

•  Delaying payment can harm a company’s relationship with its vendors and creditors

•  A growing accounts payable suggests a company may be having cash flow issues or a slowdown in sales

•  Manual data entry can result in errors, leading to incorrect calculations or incorrect payments

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What Is Accounts Receivable?

Accounts receivable is money that customers owe your company for products or services that have been invoiced. Some businesses request payment upon receipt of the invoice, while others give the recipient 30 or 60 days to pay.

Like accounts payable, accounts receivable is recorded on a company’s balance sheet. However, it is listed under current assets (and because it’s an asset, it can be helpful for securing various types of business loans). Also like accounts payable, accounts receivable is for products or services that were given on credit.

Recommended: SBA Loan Requirements

How Accounts Receivable Works

Once a company delivers goods or services to the client, the accounts receivable (AR) team will invoice the customer and record the invoiced amount as an account receivable, noting the terms (such as net-30 or net-60).

If the client pays as agreed, the team records the payment as a deposit. At that point, the account is no longer receivable. If the customer fails to pay on time, the AR team will likely send a late payment letter, which may include a copy of the original invoice and list any late fees.

If a customer is unable to pay its outstanding bill due to bankruptcy or other financial problems, the company may end up reporting it as an allowance for doubtful accounts on the balance sheet. This is also known as a provision for credit losses.

Calculating Accounts Receivable

In accrual basis accounting (which means revenues and expenses are recorded as they are incurred), your general ledger will show your total accounts receivable balance. Under cash basis accounting (which means revenue and expenses are recorded when money is exchanged), however, there are no accounts receivable, since a transaction doesn’t count as a sale until the money hits your bank account.

Several important financial ratios rely on accounts receivable, including:

•  Accounts receivable turnover ratio: This measures how efficiently and quickly a company converts its account receivables into cash within a given accounting period. The formula for calculating accounts receivable turnover for a one-year period is:

  Accounts Receivables Turnover = Net Annual Credit Sales / Average Accounts Receivables

•  Current ratio: Also known as working capital, the current ratio measures liquidity, meaning whether your company is able to pay its short-term obligations with available cash or other liquid assets. The formula is:

  Current Ratio = Current Assets / Current Liabilities

•  Days sales outstanding: This shows how long, on average, it takes customers to pay your company for goods and services. The formula is:

  Days Sales Outstanding = Accounts Receivable for a Given Period / Total Credit Sales X Number of Days in the Period

Pros and Cons of Accounts Receivable

  Pros:

•  Extending credit can increase sales and large purchases

•  Helps your company acquire new customers

•  Makes your company more competitive with its peers

•  Can be used to receive accounts receivable financing

  Cons:

•  Diligent record-keeping is required

•  May slow down cash flow

•  Estimating value of uncollectible receivables can be difficult

•  May have to work with collection agencies

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Accounts Payable vs Accounts Receivable

Accounts payable and accounts receivable are two sides of the same coin, which means they have both similarities, as well as distinct differences. Here’s a closer look at how they compare.

Similarities

•  Both represent the flow of money within a business

•  Both are recorded in a company’s general ledger

•  An overview of both is required to gain a full picture of a company’s financial health and can affect getting approved for a small business loan

•  Both revolve around short-term financial transactions

Differences

•  Receivables are classified as a current asset, while payables are classified as a current liability

•  A payable is money to be dispersed; a receivable is money to be received

•  Receivables may be offset by an allowance for doubtful accounts, while payables have no such offset

•  Payables are recognized as income unless written off; receivables are recognized as a liability until paid

Recommended: What Are Accrued Expenses?

How Are Accounts Payable and Receivable Related?

Both accounts receivable and accounts payable revolve around the flow of cash in and out of your business. As such, they are both often used to assess the liquidity of a company.

A liquidity analysis measures whether there are enough funds coming in from receivables to pay for the outstanding payables, and is often done using the current ratio (also called the working capital ratio). As mentioned above, this is simply current assets divided by current liabilities:

  Current Ratio = Current Assets / Current Liabilities

A good current ratio is typically considered to be anywhere between 1.5 and 3.

The Takeaway

Simply put, accounts payable is the money you owe, while accounts receivable is the money owed to you. Together, they represent the cash flow of a business.

Understanding and tracking accounts payable and accounts receivable can help you gauge the financial strength of your business and put practices in place to generate a healthier cash flow.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What are examples of accounts payable and receivable?

Accounts payable are expenses incurred from buying a product or service from a vendor and supplier. For example, when a company buys raw materials from a supplier on credit (meaning it doesn’t pay cash up front), this results in an accounts payable for the company.

Accounts receivables, by contrast, come from selling goods or services. If a customer orders your product and you issue an invoice due in 30 days, the amount owed will be listed as an accounts receivable until it is fully paid.

Do clients pay accounts payable or receivable?

Any money clients or customers owe to your company is listed under accounts receivable.

Should accounts receivable be higher than accounts payable?

Generally, it is better for accounts receivable to be higher than accounts payable. This means a company is bringing in more money than it spends. An accounts receivable- to-accounts payable ratio of two-to-one is often considered a sign of a healthy business.

Photo credit: iStock/utah778

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q424-039

The U.S. Small Business Administration (SBA) helps businesses qualify for financing by guaranteeing loans through lenders. These loans typically feature comparable rates to traditional business loans and sometimes require a lower down payment.

Businesses generally need to meet minimum standards and eligibility requirements in order to receive an SBA loan, and individual lenders may also have their own eligibility requirements.

Find out what type of SBA loans are available to small business owners, who may qualify, and what can be done to help improve application materials before applying.

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SBA Loan Eligibility Requirements

SBA loan requirements vary based on the type of small business loan a business is applying for. The SBA breaks down its financing options into four programs.

SBA 7(a) Loans

The most common loan is the SBA 7(a) loan. Loan amounts range from $500 to $5 million and can be used for both working capital and fixed assets. In most cases, borrowers must provide a down payment of 10% of the loan amount. At a minimum, expect to need to meet the following requirements to get approved for a SBA 7(a) business loan:

For-profit status

Operating for profit is a core SBA financing requirement. Nonprofit and religious organizations may not apply for SBA loans.

Location

Businesses must be physically located in the U.S. (or territories) and operate there as well.

Size

In order to qualify as a small business, you must meet the SBA’s standards based on annual receipts or number of employees. Use the SBA’s Size Standard Tool to find out if your business meets this qualification.

Business owner investment

The business owner must have either time or money (or both) invested in the company in order to qualify. In other words, the SBA wants to ensure you’re sufficiently invested in the business to work hard towards its success (and be able to repay the SBA loan).

Limited financing opportunities

The SBA’s “credit elsewhere test” requires lenders to document the business’s inability to get traditional business financing. Common reasons that could hinder you from getting an SBA loan include things like:

•  Not enough collateral

•  Too new to meet lender’s standards

•  Requested loan amount too high

Certain types of businesses are not eligible for SBA loans. Ineligible businesses may include:

•  Real estate investment firms

•  Firms that are involved in speculative activities

•  Businesses that sell rare coins and stamps

•  Businesses involved in lending, such as banks or other financial institutions

•  Businesses set up in a pyramid sales plan

•  Businesses that are involved in illegal activities

•  Businesses involved in gambling activities

•  Charities, nonprofits, religious institutions, and government-owned businesses

Of course, individual lenders can implement stricter guidelines if they choose. They’ll also look at a number of other factors when reviewing each business loan application.

Recommended: Guide to Typical Small Business Loan Requirements

SBA Microloans

Microloans are backed by the SBA and are designed to help businesses in the short-term with smaller loan amounts. The maximum loan amount is $50,000 and they don’t usually require a down payment. The longest loan term available is seven years.

While the funds can’t be used to pay down debt, they can be used for things like purchasing machinery, leasehold improvements, and working capital.

SBA Disaster Loans

If your business is adversely affected by a declared disaster, you may qualify for disaster loan assistance (also known as Economic Injury Disaster Loans, or EIDL). This financing helps businesses replace assets that are damaged or destroyed, including machinery and inventory.

This program differs from other SBA loans in that funds are actually provided by the U.S. Treasury, not external lenders. The maximum loan amount is $50,000 without collateral and much higher if you have collateral. Eligible businesses include:

•  Small businesses

•  Small agriculture co-ops

•  Small aquaculture businesses

•  Private non-profit organizations

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SBA 504 Loans

SBA 504 loans are for real estate and equipment financing. This SBA loan for existing businesses is designed to help expand and create jobs. Combined financing comes from both the SBA and the lender, and also requires a 10% down payment from the business.

While all of these loans are guaranteed by the SBA, financial institutions actually originate and service the loans. Minimum guidelines are set forth by the SBA, which reduces the lender’s risk. It’s possible to shop around at different lenders who have different small business loan qualifications.

The maximum loan amount is between $5 million and $5.5 million and comes with a fixed interest rate for a loan term of up to 25 years, depending on the type of loan. Businesses may qualify using an alternative size standard as long as they don’t exceed $15 million in tangible net worth and their two-year average net income doesn’t exceed $5 million.

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5 Tips for Qualifying for a SBA Loan

Following these five tips may help strengthen your SBA loan application and improve your odds of getting the financing you’re looking for.

1. Start with Existing Banking Relationships

The SBA recommends working with a financial institution with which you already do business, when possible. Not only do they have a clearer picture of your financial history, they may also have insights into your character. Even if you get an initial “no” response, that doesn’t mean you won’t be approved elsewhere. Online lenders also offer small business loans backed by the SBA.

Recommended: Unearned Revenue

2. Enhance Your Business Plan

Your business plan is one of the most important components of your SBA loan application. Lenders generally want to see a clear description of your company and your plan for moving forward. Review your business plan and make sure it’s as impactful as possible before presenting it to a potential lender.

The primary aspects of a solid business plan are:

•  Management plan: This section is a high level overview of the company. It should introduce lenders to your company and provide information on company management, including resumes and bios of owners or top tier management.

•  Financial plan: This section typically includes the key financial statements for a company. The goal is to illustrate how viable a company is.

•  Marketing plan: Consider as comprehensive a plan as possible. In addition to advertising, a marketing plan may also include things like packaging, pricing, identifying the product’s target market, and creating a plan for differentiating your company from competitors.

•  Operations plan: This section will outline strategies for developing your business. Things like company goals, procedures, and timelines are generally included in this section.

Each piece works together to assure the lender that you have a clear vision for your company that can be successfully executed with the right financing.

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3. Check Your Credit Score

Your credit score is one of the primary factors in your business loan approval. While there’s no SBA loan credit score minimum, lenders may have their own individual standards. In fact, they’ll likely evaluate both your personal and business credit scores to determine how likely you are to repay a loan.

Your personal credit score comes from the three major credit bureaus: Experian, Equifax, and TransUnion. Before applying for an SBA loan, request a free copy of all three credit reports and make sure they’re accurate.

If your company is already established, you may also have a business credit score. In addition to Experian and Equifax, Dun and Bradstreet is another common resource for lenders to gauge your financial history. Data points typically include business loans and credit cards. Unlike your personal credit report, you’ll usually have to pay a fee to request copies of your business credit reports. It’s usually worth checking that all of your credit accounts are represented correctly before you apply for other funding.

Recommended: Does a Business Loan Affect Your Personal Credit Score?

4. Explain Upcoming Changes in Cash Flow

Cash flow is also an important factor because it demonstrates whether or not your company can handle both current operating expenses and a new loan payment. Not having enough cash flow can be a red flag to lenders. You’ll likely need to present historical cash flow as well as a 12-month projection as part of your application. Both sets of financials demonstrate how well the company will be able to handle the loan.

You may also wish to describe how your cash flow may improve as a result of new revenue streams or other future changes resulting from getting approved.

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5. Weighing the Pros and Cons of Using Collateral

Collateral isn’t required to get approved for an SBA loan (up to a certain amount), but it may improve your chances if your credit and cash flow aren’t ideal. Both personal and business assets may be used to secure an SBA loan, including inventory, equipment, real estate, and cash savings. For real property, make sure you know the true appraised value of your asset, otherwise you might be disappointed by the bank’s appraisal.

Also recognize the inherent risk that comes with getting a secured business loan. You could lose that property in the event you default. Depending on your risk appetite and the state of your business, you may or may not feel comfortable offering any collateral.

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Alternative Business Loans

In addition to SBA loans, explore other small business loan options to make sure you get the best financing deal possible. Online loans are an alternative to both SBA and traditional bank loans. They are often unsecured business loans and may be more flexible with credit scores. The approval process may be faster than with an SBA loan, as well.

Depending on your business, crowdfunding may be another option to consider, especially if you’re launching a product or service that would appeal to a large mass of consumers.

Crowdfunding platforms allow you to fundraise towards a specific financial goal, sometimes offering donors different levels of rewards based on their contributions. Alternatively, you could fundraise in exchange for partial company ownership through an equity-based crowdfunding platform.

There are also some collateral-based financing opportunities, such as merchant cash advances, equipment financing, or accounts receivable financing. While you may get a needed infusion of capital with any of these options, they typically come with expensive APRs and fees.

Finally, it may be worth exploring small business grants, which provide a lump sum and don’t require repayment. Your company typically needs to be in a qualifying industry to apply, and grants can be competitive to get.

Recommended: Conventional Business Loans vs SBA Loans

The Takeaway

SBA loans are designed to help small businesses get the capital they need to succeed. Explore all of the loan options and eligibility requirements to find the best options. Remember that approval qualifications and loan terms are likely to vary from lender to lender, even for the same type of SBA loan.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is needed for an SBA loan?

To qualify for an SBA loan, businesses typically need a strong credit score (usually 680 or higher), proof of a solid business plan, financial statements, tax returns, collateral, and personal guarantees. Additionally, the business must meet the SBA’s size requirements and demonstrate the ability to repay the loan.

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What disqualifies you from getting an SBA loan?

You can be disqualified from an SBA loan for having a poor credit score, insufficient collateral, lack of repayment ability, or a weak business plan. Additionally, involvement in illegal activities, speculative businesses, or businesses outside SBA size standards can lead to disqualification. Previous loan defaults may also disqualify applicants.

Is an SBA loan hard to get?

Yes, SBA loans can be hard to get due to strict eligibility criteria, including a strong credit score, solid financial history, and detailed documentation. The application process can be lengthy and competitive. However, businesses with good credit, solid financials, and a well-structured plan can improve their chances.

Photo credit: iStock/seb_ra

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
This content is provided for informational and educational purposes only and should not be construed as financial advice.

SOSMB-Q424-038

With accounts receivable (AR) financing, you use your outstanding invoices to receive quick access to capital, either by selling those invoices or by using them as collateral to receive a loan.

Unlike many types of business loans, AR financing usually doesn’t require a minimum credit score, revenue, or years in business. However, there are some tradeoffs involved. Here’s what you need to know about accounts receivable financing.

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What Is Accounts Receivable Financing?

For businesses that issue invoices to clients, accounts receivable financing (also known as invoice financing) is a way to get an advance on the balances owed on those invoices, minus fees.

What Is Accounts Receivable?

Accounts receivable is a term that refers to money that your customers owe you. This differs from accounts payable, which refers to bills from vendors you need to pay. Whether you use cash or accrual accounting, accounts receivable is listed on the balance sheet as an asset, since it’s money that is owed to the company.

Accounts receivable financing is a type of small business financing that is based on the value of your accounts receivable. In some cases, AR financing involves selling those invoices at a discount. In other cases, you use the invoices as collateral for loan or line of credit.

Essentially, AR financing allows you to use capital that would otherwise be unusable until your customers settle their invoices.

How Does AR Financing Work?

When you apply for a business loan, lenders typically want you to have certain credit scores, time in business, and revenues. With AR financing, on the other hand, the lender approves the funding and loan amount by reviewing your clients’ payment history, weighing their creditworthiness more heavily than your own. As a result, this can be a good funding option for small businesses with a limited or poor credit history.

In general, the process looks like this: You apply for financing through an AR lender and submit your outstanding invoices. Once approved, you’ll be advanced an amount, typically less than the full amount of the invoices. The advance may be structured as an asset sale (called factoring) or as an invoice-backed loan or line of credit. How it works from here will depend on the type of AR financing you choose.

Types of Receivables Finance

There are actually three different types of accounts receivable financing, and each works slightly differently. Here’s a closer look.

Asset-Based Lending (ABL)

With asset-based lending, you use an asset as collateral to receive financing. With asset-based invoice financing, you use your accounts receivables as collateral to get a loan or line of credit from an invoice financing company. You’ll pay interest on the amount you borrow and retain ownership of the invoices. However, you must repay the loan based on the agreed terms, regardless of whether your customers fully pay their invoices.

Traditional Factoring

With invoice factoring, you sell your accounts receivables to a factoring company. The company will typically give you less than the invoice value (often 70% to 90%) up front. They are then responsible for collecting on the invoices directly from your customers. Once your customers pay, the company will take out fees and forward you the balance.

One advantage of factoring is that you won’t have to chase down payment from your customers. However, factoring tends to cost more than asset-based invoice financing, since the factoring company does more work to collect payments. Also keep in mind that having a third party interact with your clients could damage your business relationships.

Selective Receivables Finance

With traditional invoice financing, you typically upload all outstanding invoices and get an advance based on that number. With selective receivables financing, on the other hand, you can pick and choose which invoices you want to use for financing.

For example, maybe you know that one client, who has a $7,500 monthly retainer, pays a little late but is still reliable in paying. That might be the receivable you want to use for financing, since you’re confident the invoice will get paid.

Financing rates for selective receivables financing are typically lower than other types of invoice financing, due to the high quality of the receivables. In addition, this type of financing can sometimes be structured so it won’t show up on your company’s balance sheet — or impact your ability to qualify for other types of business financing.

Pros and Cons of Accounts Receivable Financing

Is accounts receivable financing a good option for your business? Here’s a look at the overall benefits and drawbacks of this type of funding.

Pros

The process of securing invoice financing is typically faster than traditional loans. This speed can be critical for small businesses that need quick capital. It’s also generally easier to qualify for invoice financing, since approval is based on the creditworthiness of the clients who owe the invoices, rather than the business itself.

Accounts receivable financing can also improve your company’s cash flow, allowing you to invest in improvements, pay suppliers, and promote business growth before customers pay balances fully. And in the case of factoring, it also allows you to completely wash your hands of the stress of getting clients to pay invoices.

Cons

On the downside, the cost of accounts receivable financing is typically higher compared to more traditional types of business financing, such as a term loan from a bank.

And if you go with AR factoring, you will lose control over communication with your clients. If you go with AR lending, on the other hand, you’ll still be on the hook for getting your clients to pay their invoices, or you may have to pay your debt out of pocket.

This type of financing is also limited in scope, since it only applies to businesses with outstanding invoices. Companies with cash sales or advance payments may not benefit from this financing model.

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The Takeaway

Accounts receivable financing is a way for businesses to access cash by using their unpaid customer invoices as collateral for a loan or by selling them to a factoring company.

This type of financing could be useful if you experience cash flow gaps due to delayed customer payments, as it allows you to maintain steady operations without waiting for receivables to clear. But there are some downsides involved, including costs. Before you jump into AR financing, it’s a good idea to weigh the pros and cons and compare it to other funding options that may be available to your small business.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the difference between factoring and accounts receivable financing?

Factoring and accounts receivable (AR) financing are both ways to access funds based on outstanding invoices, but they differ in structure. Factoring involves selling invoices to a third-party company at a discount; this company then collects directly from customers. In AR financing, the business retains ownership of the invoices and borrows against them, using the invoices as collateral. While factoring is typically faster and offloads collections, AR financing allows the business to maintain control over client payments and customer experience.

Is a loan considered accounts receivable financing?

A loan is different from accounts receivable financing. With a traditional loan, a business borrows a lump sum from a lender and repays it with interest over time, regardless of invoices. With accounts receivable financing, a business accesses funds by borrowing against their unpaid invoices, using them as collateral.

What is an example of an account receivable?

An account receivable is money owed to a business by a customer for goods or services provided but not yet paid for. For example, a consulting firm might complete a project for a client and issue an invoice for $3,000, giving the client 30 days to pay. Until the payment is received, this $3,000 invoice is considered an account receivable for the consulting firm. The receivable will appear as an asset on the firm’s balance sheet, since the customer is legally obligated to pay the debt and the company expects to collect it.

Photo credit: iStock/MIND_AND_I

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

SOSMB-Q424-055

Paying your employees accurately and on time is one of the most important aspects of running a successful small business. Unfortunately, it can also be one of the most complicated.

That’s because running payroll isn’t just a matter of cutting checks and handing them out to your employees. It typically also involves complying with state and federal labor and tax laws, calculating the right amounts for deductions and withholdings, and filing payroll taxes.

If you’re a small business owner and wondering how payroll works for a small business, here’s what you need to know.

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What Is Payroll?

Payroll is the process of paying your employees. Running payroll generally consists of calculating employee earnings and factoring out federal and state payroll taxes. However, payroll can also refer to a few other things, such as:

•  A financial record of a business’s employees

•  An annual record of employee wages

•  The actual payment and delivery of paychecks to employees

From a small business owner’s perspective, payroll is also a business expense, often one of the largest you pay out each month.

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Why You Need a Payroll System

The most obvious reason for needing a payroll system is that you need to pay people who work for your company. But payroll systems aren’t just about paying employees. They also track who is working for your company, how long they’ve worked for you, and how much money you’re spending on labor.

Having a proper payroll system in place can also prevent problems for your small business. If you enter deductions or file payroll taxes incorrectly, you could run into issues with the Internal Revenue Service (IRS), incur fines, and expose your business to severe liability. A reliable payroll system can ensure:

•  Timely and accurate payments to your employees

•  State and federal regulations are followed

•  Payroll taxes get paid on time

•  Proper deductions and withholdings occur

Recommended: What Is an Employer of Record?

Can You Do Payroll Yourself?

Yes, you can do payroll yourself. You’re not legally required to hire anyone or use any type of software. If you’re a small business owner who only employs a few people, it may be worth learning how to do payroll on your own.

However, it can be time-intensive and entail making numerous calculations. If you’re new to payroll, you will likely have to do extensive research to make sure you are up to date with all labor and tax laws.

The upside of doing it yourself is that it’s typically the least costly way to do payroll. Keeping the process in-house can also give you complete oversight and control over the process.

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Tips for Doing Payroll for Your Small Business

Whether you choose to do payroll manually with a spreadsheet or by using a payroll software program or outside service, it can be helpful to understand the payroll process. Below, we’ve broken it down into seven basic steps.

1. Get an Employer Identification Number (EIN)

An EIN (also called a Tax ID) is a unique number given to your business for IRS purposes. This number identifies your business when reporting information about your employees to federal and state government agencies. It’s like a Social Security number, but it’s only used for businesses.

If you have employees, you need an EIN. It’s free, and easily obtained through the IRS.

2. Enroll in the Electronic Federal Tax Payment System (EFTPS)

A major part of running payroll involves paying payroll taxes on time. The EFTPS is a free payment system that allows you to pay both your federal payroll and your federal unemployment taxes right from your computer using the EFTPS portal.

If you are using a payroll service, you can likely skip this step since they typically will be sending in your tax payments for you.

3. Research Local, State, and Federal Labor Laws and Regulations

Many states and counties have different labor and pay laws. If you’re not using a payroll service, it can be a good idea to learn what these laws are, since they impact the type of information you need to have printed on paystubs, as well as how much and how often you’re required to pay your employees.

Sometimes labor laws can be difficult to navigate because you have to comply with all three levels of government at the same time — local, state, and federal. If laws differ, an easy rule to follow is to obey the law that gives the greatest benefit to your employees.

For example, a common discrepancy is minimum wage. Currently, the federal minimum wage is only $7.25 an hour. However, many states mandate that employers pay their employees considerably more. California, for example, currently requires all employees to make at least $16.00 an hour. If you’re an employer in California, you must obey your state’s laws and ignore federal minimum requirements because the state mandate is higher than the federal mandate.

Local, state, and federal labor laws may also impact:

•  How you need to calculate overtime

•  Paid vacation requirements

•  If you’re required to withhold money for state disability insurance

•  If you need to withhold local income tax

•  Your workers’ compensation insurance requirements

When using payroll software or an outside payroll company, you typically don’t need to have as much in-depth knowledge of pay and tax laws, since they’re usually already applied to the software.

4. Select a Payroll Schedule

As long as you conform to any minimum state requirements, you can pay your employees as often as you like. No matter what pay interval you choose, you may want to keep in mind that it is going to impact your company’s cash flow, as well as when you are able to pay vendors. The most common payroll schedules are:

•  Weekly

•  Biweekly

•  Monthly

5. Request Workers to Complete Their New Hire Forms

New hires need to fill out the proper paperwork as soon as possible because you can’t process payroll without the details provided on these forms. Each hire needs to complete and turn in:

•  State tax withholding form

•  W-4

•  I-9 Employment Eligibility Verification Form

•  Direct deposit authorization form (if you offer this service)

Many payroll service providers will gather these forms on the employer’s behalf.

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6. Calculate Net From Gross Pay, Deductions, Allowances, Other Withholdings

Net pay is what each employee is paid at the end of each pay period. Calculating an employee’s net pay involves some complicated calculations, but the overall formula is simple: Net pay equals gross pay minus payroll deductions.

Gross Pay: How you calculate your employee’s gross wages will depend on if your employee is an hourly or salaried employee. For hourly employees, you can multiply the total hours they worked in the pay period by their hourly wage. For salaried employees, you can divide their total annual salary by the number of pay periods you have throughout the year; this will give you their gross wage for each pay period.

Deductions: Payroll deductions are wages withheld from an employee’s total earnings for the purpose of paying taxes, garnishments, and benefits like health insurance. These withholdings constitute the difference between gross pay and net pay and may include:

•  Federal taxes

•  Social Security

•  State taxes

•  Local taxes

•  Medicare

•  401(k) contributions

•  Wage garnishments

•  Workers’ compensation contribution

•  Other benefits

The amount you withhold for each employee will depend upon that person’s W-4, state and local withholding certificates, benefit selections, and other details. You can calculate these withholdings manually or you can automate the process by using an online payroll calculator or payroll software program.

Below is a general step-by-step to help you calculate payroll deductions. If you’re new to running payroll and will be doing it manually, it’s a good idea to consult an accountant the first time you do it to make sure you’re not running afoul of any federal and state tax and employment requirements.

•  Adjust the employee’s gross pay by withholding pre-tax contributions to health insurance, 401(k) retirement plans, and other elected benefits.

•  Check the employee’s Form W-4 (one of many common tax forms) and the IRS tax tables for the current year to calculate and deduct federal income tax.

•  Withhold 7.65% of adjusted gross pay for Medicare tax and Social Security tax, up to the wage limit. (Your business is legally obligated to match this amount.)

•  If the employee’s year-to-date income has reached $200,000 or more, deduct 0.9% for Additional Medicare tax.

•  In states that charge income tax, withhold this tax according to the instructions found in each state’s employer’s tax guide or code.

•  Subtract any garnishments, contributions to Roth IRA retirement plans, as well as other post-tax dues to arrive at the employee’s total net pay.

7. Keep Records, Adjust, and Fix Mistakes

Maintaining honest and organized payroll records is important for any business. This allows you to reference your records if there’s ever a discrepancy between an employee’s net pay and what they expected to receive. Mistakes happen, but as long as you correct them quickly and honestly, you can generally recover quickly.

Having these records on hand can also be key in the event you have to work with the IRS. The IRS requires employers to keep records of employment taxes for at least four years.

Recordkeeping is also essential for payroll taxes that you have to pay out on a regular basis.

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Alternatives to Running Payroll by Yourself

If the idea of setting up and running your own payroll system feels overwhelming, you may want to consider some alternatives that can make your life a little easier.

Payroll Software

Payroll software is often the least costly option outside of doing it yourself. Aside from being a time-saving measure, many of these programs offer automatic updates to tax regulations, reminders, and an additional layer of security.

There are numerous payroll software programs on the market. These include:

•  ADP

•  Gusto

•  Workful

•  Quickbooks Payroll

•  Paychex Flex

•  OnPay

•  Payroll4Free

•  Rippling

Payroll Services Provider

If you are willing to pay a bit more to have the whole payroll process taken off your hands, you may want to look into hiring an outside company that specializes in payroll services. That can also be an important step as you grow your business (as are moves like taking out a small business loan).

A full-service organization can often handle all payroll processing, direct deposits, printing of checks, tax payments, withholdings, and tax filing.

CPA or Bookkeeper

Another option is to hire an individual who is experienced in running payroll to handle the process for you. If you go with a CPA, they may also be able to help you with general small business accounting needs.

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The Takeaway

Running payroll for your small business is a cumbersome but necessary task. If you’re willing to put in some time and effort, you can likely do payroll yourself. If you’d rather focus on other aspects of your business, it may be worth it to purchase payroll software or to hire an outside payroll company to handle the whole process.

Once your payroll system is in place, you may want to look for other ways to improve and grow your company. SoFi’s marketplace makes exploring your small business loan options easy.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Can a small business do its own payroll?

Yes, it is possible for a small business to do its own payroll with time, education, and effort. It’s a complex process, but it can also save the business owner money. As your business grows, you can then consider hiring an outside payroll service.

How do I create a simple payroll?

There are several steps to creating a simple payroll. These include getting an employer identification number, enrolling in the Electronic Federal Tax Payment System, researching labor laws and regulations, choosing a payroll schedule, having employees fill out the necessary forms, calculating net pay, and keeping records.

What are different ways to do payroll?

A few of common options for a small business to do payroll is to keep the process in-house and manage it yourself, use payroll software, or use an outside business to handle payroll. Each has its pros and cons. For a new and/or small business, doing your own payroll (at least at first) may be a good move.

Photo credit: iStock/damircudic

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

This article is not intended to be legal advice. Please consult an attorney for advice.

SOSMB-Q424-021

If you want to start a wedding planning business and make those “big days” even better, there are multiple routes you can take to establish yourself as an industry professional.

As you likely already know, planning weddings isn’t as simple as it sounds. Making sure a couple’s ceremony and celebration unfold without any hiccups entails much more than simply helping them choose centerpieces and DJs.

If you’re thinking about starting a wedding planning business, here’s what you need to know.

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What’s the Wedding Business Like?

The wedding business is a business of moving parts and pieces. To be a successful wedding planner, it’s essential to have strong organizational skills and be calm under pressure.

Wedding planners help couples with a variety of tasks, such as:

•  Communicate with vendors for food, decor, music, and more

•  Send out invitations

•  Plan receptions

•  Secure venues

•  Manage finances

•  Track RSVPs

The list could go on and on. While there are websites and apps to help couples plan their big day, many couples prefer to work one-on-one with a wedding planner to make their wedding day as perfect and personalized as possible. Weddings are a lot of work, and, for the months leading up one, planning can be a full-time job. This is where wedding planners come in.

The good news is that starting a wedding planning business from home is very doable. Since you will most likely spend your time meeting virtually with clients or visiting vendors and venues, there’s no reason to spend money on an office space in the beginning. As any business owner will tell you, one of the best tips for starting a business is to save money any way you can. Using your home as an office is one way to do that.

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Steps to Starting a Wedding Planning Business

There is no single right way to start a wedding planning business, but here are a few steps you can take to help you get started.

1. Determine the Type of Wedding Planning Business You Want to Start

Weddings require many people to ensure everything goes as planned. When starting your business, maybe you want to niche down and only focus on one part of the wedding. The paths a wedding planner can choose include:

1.   Full-service wedding planner: You plan everything, beginning to end.

2.   Day-of wedding planner: Help keep couples on time and on top of everything that needs to be done the day-of.

3.   Destination wedding planner: Destination wedding planners scout locations that the couple may want to get married in, whether that means within the U.S. or abroad. They learn about local rules and regulations, and speak with community vendors on the couple’s behalf.

4.   Month-of wedding planner: Designed for couples who want to plan their entire wedding themselves but still want some help speaking with vendors, managing payments, and arranging deliveries.

5.   Weekend coordinator: Weekend coordinators are best utilized by couples who are having multi-day weddings with many guests and non-wedding activities.

6.   Custom wedding planner: Perhaps you want to offer your clients an à la carte approach. For this, customers choose which services they want your help with.

7.   Vendor specialist: A vendor specialist helps couples review contracts, gives them referrals for noteworthy companies, and helps them scout out various venues and vendors they may be considering.

Of course, you may have a skill that you want to market that is not listed above. In that case, you may have to educate the marketplace and prospective customers about your offerings in order to build your business.

2. Take an Online Course

While you may feel as if you have enough real-world experience to figure everything out on your own, the reality is you don’t know what you don’t know. One way to enhance your knowledge of the wedding industry and how to run a wedding planning business is by taking an online course.

There are many sites that offer online courses — such as Udemy and Teachable. The courses are often affordable, and you’re usually learning from someone who actually works successfully in the industry.

3. Determine Your Ideal Client and Write a Business Plan

It’s important to focus specifically on your ideal client early on during the planning phase. This will help you develop focus (perhaps that means second marriages vs. first) — not only in your marketing and advertising, but also when choosing which vendors you want to work with.

Once you’ve determined your ideal customer, keep them in mind plotting your path, such as creating a 5-year business plan.

4. Choose a Business Structure

You will want to choose a business structure early on to ensure you have the appropriate amount of liability protection and are maximizing your tax savings. When you’re first starting out, an LLC may make the most sense because as the business owner, you are not personally liable for any damages that are a result of your business.

If you don’t take any steps to formally establish your business, then it will automatically be either a sole proprietorship or a partnership. While this structure is the simplest, if you are sued by a client, your personal assets could be taken to settle any debts.

5. Register and get an EIN

Once you’ve decided on a business structure, you will want to register your business. The Small Business Administration has a detailed web page on everything you need to do to register.

Even if you do not have any plans of hiring an employee in the near future, you should consider getting an EIN or employer identification number. Having an EIN will enable you to open a business bank account and will make getting a business credit card easier.

6. Secure Funding

As a new business, you’re likely to have startup costs, but compared to other businesses, the costs of starting a wedding planning business shouldn’t be too high.

If you do find you need funding, consider a small business loan. Small business loans utilize a variety of terms, interest rates, payment structures, and collateral requirements. Therefore, you can take out a small business loan that truly works for you and your needs.

7. Market Your Services

In order to get your wedding planning business up and running, you must market your services. One way is to go to local bridal boutiques and speak with the business owners. Ask if you can leave a stack of business cards with them. You may also want to do the same with any seasonal trade shows.

Next, advertise on social media and work on getting a social media following. The most important thing with social media is to post consistently. Not only will this keep your audience engaged with you, but it will also help establish you as an expert in the wedding planning arena.

It can also be valuable to have a website that explains your services and competitive point of differentiation and can help you as you get reviews and build your reputation.

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How to Write a Business Plan as a Wedding Planner

Business plans sound complicated, and for many people the thought of writing one may feel intimidating. However, business plans, at their core, are simply strategies. Ask yourself what you want to accomplish and how you plan on accomplishing it.

In the beginning, have your business plan revolve around the following:

•  Company description: What will your company do? Who will it serve?

•  Competitors: Look at what your competitors do to gather business. What services do they offer? How much do they charge?

•  Legal structure: Who runs your business and how is it structured?

•  Services: Will you only offer one service, or will customers be able to pick and choose what they want?

•  Advertising and marketing: How will customers find out about you?

•  Funding: How much money is needed to get started?

Once you’ve written your business plan, revisit it every quarter. A business plan is a living document, meaning you are free to change it as many times as you see fit until it feels right.

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Methods to Receive Funding

There are many different ways to raise capital to start a business. The more traditional routes include:

•  Bootstrapping: Save until you can fully fund all expenses on your own without any outside help from lenders or investors.

•  Investors: As a new start up, you may have trouble securing funding through an investor. However, if you have a unique angle to offer the world, investors may want to buy in early.

•  Partnership: Adding a business partner means they will share the financial burden with you, but you will have to split profits with them as well.

•  Crowdfunding: Crowdfunding takes many forms and involves getting small amounts of capital from a large number of people. One option is to pursue donation-based crowdfunding so you don’t have to relinquish any equity or go into debt.

•  Grants: Small business grants do exist, but there will be plenty of competition. Definitely research and apply, but don’t let it be your only option.

•  Business loan: There are many business loan options, including startup business loans for those that are just getting their business up and running.

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The Takeaway

Starting a wedding planning business from home is doable, but it will take work, persistence, and strategizing. Determine what services you want to offer, who your ideal client is, and how much you will charge vs. your competitors. Once you know this information, you can begin to plan and implement.

If you feel like you need extra capital to get started, a small business loan may be the solution. SoFi’s marketplace can help.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What qualifications do I need to start a wedding planning business?

While a college degree or certification is not necessary to start a wedding planning business, you do require some knowledge. For this, you may consider taking an online course on starting a wedding planning business or asking other local wedding planners if you can shadow them.

How much should I charge for my services?

This depends on what services you plan to offer and your level of expertise and experience. Determine what you want to offer and research what your competitors charge. As you gain more clients and more experience, you can always choose to increase your rates.

How do I market my wedding planning business?

You might visit local boutiques and see if you can leave cards or advertise with them at their front counters. Other options include placing ads in wedding magazines and on wedding websites and using social media to grow your business. Also, you might establish a website to help you get Google reviews as early as possible.

Photo credit: iStock/LumiNola

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q424-020