July 26, 2022
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A broken car, an urgent plumbing job around the house, a hefty medical bill… There are numerous situations that can put your employees in a position where the next payday simply can’t come soon enough. As an employer, it’s normal to want to support employees in difficult times and make sure they don’t get into financial trouble over a bill that arrived at a bad moment.
What employers can do in such situations is to offer a paycheck advance. Unfortunately, many businesses don’t know how to properly manage and record salary advances. This blog post will tell you everything you need to know about payroll advances, including how they work, what the pros and cons are, and how to avoid potential pitfalls.
Let’s start with the basics first. What exactly is a payroll advance? Offering employees a payroll advance means giving them a short-term loan to cover the period until their next official payday. Salary advances have predetermined repayment terms, which usually define a schedule according to which the loan is taken out of the employee’s future paycheck(s). As a means to improve employee financial well-being, they can be a good addition to the employee benefits package you offer your global team.
Remember that a payroll advance is not the same as a payday loan which is another type of short-term loan provided to employees who are facing financial difficulties. The difference is that payday loans come with much higher interest rates (usually between 15% and 30%) and can therefore worsen an employee’s financial situation in the long term - especially in cases of employees who are notoriously short on cash. Also, payday loans are typically not provided directly by the employer, but by separate lenders.
Now that we’ve defined what a cash advance in payroll is, it’s time to see how the process works. Managing payroll advances typically involves several different steps which are:
Setting guidelines and rules for paycheck advances
Approving the employee’s request and formalizing the advance in writing
Delivering the salary advance
Getting a confirmation of receipt
Recording the advance in your bookkeeping
Managing the repayment
The first step is to define which employees can request an advance, and under which circumstances. This is usually done in the form of a payroll advance policy (we’ll tell you more about this at the end of the blog post), which simplifies the approval process.
Employees should request salary advances in writing, and if the request is approved, you should make sure to sign a written agreement with your employee, spelling out the amount as well as the repayment terms, before you actually deliver the advance.
Payroll advances can either be made available to employees via check, direct deposit or any other alternative pay method typically used for paying employee salaries. Just keep in mind that advances should be processed as an off-cycle payment, i.e. separately from your standard payroll run. Once the payment has been made, make sure to get your employees to sign a confirmation of receipt to avoid any potential disputes later on.
After the payment has been issued and your employee has confirmed the receipt, the only thing left to do is to record the payroll advance in your payroll bookkeeping and to make sure the advance is repaid within the specified timeframe. Depending on the amount of the advance, the money may be deducted from one or several future paychecks.
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From the perspective of an employer who cares about their employees, payroll advances seem like the obvious thing to do. Your employees struggle financially, and as a good employer, you help out by providing them with a pay advance. However, there are also some drawbacks that should be considered. Time to weigh the pros and cons to see whether offering paycheck advances is really the way to go.
Let’s start with the advantages. Salary advances are a great way to diversify your compensation strategy and show your team that you care about their financial security and well-being.
Providing payroll advances as an employee benefit can go a long way to increase employee happiness and morale, which can help reduce turnover rates. What’s more, knowing they’re financially secure takes the pressure off employees, which helps support their mental health and can make them more productive.
On the other hand, employees might take advantage and claim a salary advance which they’ll never pay back in full. If this happens on several occasions, it could have a negative impact on the business’s cash flow. The same holds true if employees fail to pay their payroll advance back in the agreed timeframe.
Furthermore, managing payroll advances means more work for the business (paperwork, additional payments etc.) and the rules and regulations governing payroll advances add yet another item to the list of compliance risks businesses have to deal with. Not to forget the additional effort to set up a payroll advance policy.
The pros and cons of payroll advances at a glance
We’ve already come across some of the potential pitfalls of offering employees a payroll advance when discussing the pros and cons of payday advances, but let’s look at these problems more closely.
First, it’s important to know that there are several laws and regulations that have a direct or indirect impact on how companies handle payroll advances. For instance, deducting the advance from your employee’s paycheck mustn’t decrease their earnings to below minimum wages. Depending on the country, the interest rates employers are allowed to charge for salary advances may also be regulated, as is the case in the United States, for instance. So make sure to stay compliant.
Second, offering employees payroll advances means taking a financial risk, since you pay out money to employees for work they haven’t actually completed yet. If, after the advance, the employee’s performance begins to slip (up to the point where you have to consider dismissal), there’s a chance that you’ll never fully recover the advance payment you made.
To stop any potential negative consequences on your business’s cash flow, you can either opt for on-demand pay (also known as earned wage access, which means that employees get early access to the part of their wages they’ve already earned) as an alternative to paycheck advances or set strict eligibility criteria employees need to fulfill in order to receive an advance. The latter is usually part of a clearly defined payroll advance policy.
The best way to handle salary advances and to prevent any problems is by setting up a detailed payroll advance policy which outlines the procedures that need to be followed and which spells out the specific terms both employee and employer need to abide by. The most important aspects to cover include:
Eligibility: Define which employees are eligible for a salary advance. Eligibility criteria could include seniority, completion of probation period, salary level and full-time position.
Maximum amount: Decide what the maximum payroll advance is you want to offer. Consider repayment schedules and available funds.
Procedures: Outline how employees must request payroll advances - be sure to make written requests a must - and what the processing steps are.
Written agreement: Whenever you provide a cash advance to one of your employees, you should conclude a written agreement. Since it’s only a matter of time until the first employee will request an advance, you should draft up said agreement upfront and keep it at hand.
Repayment: Make sure to include clear terms for the repayment of the loan, i.e. repayment plan, interest rate etc.
Frequency: Paycheck advances should be for financial emergencies only - and not become a regular thing your employees depend on to make ends meet. Therefore, you should limit how often an advance can be requested, for example twice a year.
Exceptional circumstances: There may be situations during which your business won’t be able to afford giving advances to employees, e.g. bad economic situation. Specify these circumstances so that employees know what to expect.
If you’re relying on payroll outsourcing, make sure to align your payroll advance policy with your service provider who will handle paycheck advances on your behalf.
Need help finding an experienced payroll service provider to set up payroll in a new market? At Lano, we work with a global network of trusted payroll partners covering over 150 countries. Plus, you get access to an automated global payroll platform that allows you to consolidate all your global payroll data in a single dashboard with multiple reporting features. Book a demo with our expert team to see our platform in action.
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