What small business owners can do when they can't afford employee salaries
Learn about our editorial policies
Almost every business goes through periods of growth, stagnation, and decline—especially when it's just starting. Even when they've been around for a while, cash flow challenges affect businesses of all sizes. Some of the biggest names in retail see a dip in the post-holiday months of January and February, and no one is immune from economic downturns.
But what if things get so bad you find yourself unable to pay your workers? That's a serious issue. Employees depend on their wages for their own livelihoods, and labor laws generally require timely payment.
There are some things you can do to alleviate a payroll squeeze. In this article, we'll discuss some recommendations, including:
- Immediate steps to take
- Ways to improve short-term cash flow
- Alternatives to layoffs
- Legal considerations
- Insurance strategies
- What should you do first if you can’t make payroll?
- Ways to cover payroll during a short-term cash flow crunch
- Can you reduce payroll costs without laying off employees?
- What happens if you can’t pay employees on time?
- Signs payroll challenges are becoming long term
- Can insurance help if a covered event leaves you unable to pay employees?
- How employment practices liability insurance (EPLI) can help protect your business
- Build a financial safety net before payroll becomes a problem
- Get the right insurance to protect your company with Insureon
What should you do first if you can’t make payroll?
When facing a liquidity shortfall, you might panic and hope that the problem will go away on its own. Unfortunately, it won’t. So, it’s best to address the issue head-on. This involves talking to the people most affected and taking stock of the situation.
Communicate with employees immediately
If your employees may soon miss a paycheck, then your first priority is to talk to them. While this will undoubtedly be a hard conversation, it’s important to be as transparent as possible. After all, you have the responsibility as their employer to pay them. If that’s become difficult, then you have a responsibility to be honest with them.
While you don’t have to get into the nitty-gritty or divulge your financial statement to your staff, you should share realistic timelines. Also let them know that you’ll update them as soon as possible with any developments.
Speaking to your employees doesn’t eliminate any legal payroll obligations you have to them. However, it can help to preserve employee relationships. If you display empathy and show you’re doing everything you can to help them, their minds will be more at ease. It will be a big step toward maintaining trust and morale among your workers, which will also be reflected in their work.
Understand the scope of the problem
If a patient goes to a clinic with a complaint, the doctor will conduct a clinical assessment to evaluate the cause of their symptoms. If your small business is running into obstacles that could affect payroll, you need to do the same thing. Ask yourself questions like:
- Is this a temporary cash flow gap?
- Are customer payments delayed?
- Has revenue declined significantly?
- Did a covered event disrupt obligations? (Some policies are named perils and others are open perils coverage.)
Use financial reports to analyze the data. The goal is to pinpoint the cause of the cash shortfall or identify patterns that can be addressed.
Prioritize payroll over non-essential expenses
Once you have a clearer idea of where the problem lies, then you can evaluate expenditures to see where you can cut back. Review all discretionary spending. If something isn’t critical for keeping the doors open, determine if it can be delayed or canceled. One important expense to keep an eye on is subscriptions. These are typically charged monthly or annually without you needing to actively renew, so they can easily slip past your notice.
Give the same consideration to upcoming projects. If you had something like a remodel, marketing campaign, or equipment upgrade in the works, see if you can postpone it until your current financial crisis eases.
You also want to turn the magnifying glass on yourself. When things get tough, you may need to consider reducing owner compensation. If your workers see that you are willing to take a hit before targeting employee wages, that will create a lot of goodwill. Plus, your personal finances may be in better shape than some of your workers.
Ways to cover payroll during a short-term cash flow crunch
There are a few opportunities that you can explore to help recover cash during a shortfall.
Use outstanding invoices to improve cash flow
There are a few different ways to address bills that haven't been paid by your customers. They include:
- Invoice factoring: With invoice factoring, you sell your unpaid invoices to a third party. That company then assumes ownership of them.
- Accounts receivable (AR) financing (or invoice financing): AR financing is more like a line of credit. You use your outstanding bills as collateral to borrow money, but you still maintain control of your invoices.
- Collections: This is always an option for accounts in arrears. It allows you to recover the money owed to you, either through your internal accounting department or a third-party agency. Alternatively, it can be written off as bad debt. If you have many customers who fail to meet their obligations to you, you might want to consider trade credit insurance or debtor insurance.
Explore short-term business financing
Another option is to bring in outside money to tide you over during a shortfall. Common forms of financing are:
- Business line of credit: With this, you are approved up to a certain amount and only pay interest on the amount you borrow. Most are revolving, meaning once an amount is paid back, your line of credit replenishes.
- Working capital loans: This type of loan gives you a lump sum, and you pay it in installments. It's typically used to cover day-to-day operations, such as payroll.
- SBA loan programs: The U.S. Small Business Administration (SBA) provides a guaranty for this kind of financing. That means financial institutions may be more willing to offer them to new businesses or ones without great credit. These loans have low interest rates and more flexibility with payment schedules. However, you need to meet strict eligibility requirements.
Renegotiate payment terms with vendors
A potential way to free up cash for payroll and essential operations is to examine your accounts payable and see if there is any flexibility there. While this strategy isn’t guaranteed, restructured repayment plans could be a way to get what amounts to a short-term loan without going through a bank or even paying interest.
You can request temporary payment extensions or suggest installment arrangements. However, don’t frame the discussion around your inability to pay now. Instead, focus on your clean payment history. Also, provide a specific proposal, such as moving all invoices over X amount of dollars from net-30 to net-45.
Perhaps most importantly, don’t try to do your negotiations when you’re already overdue. The best timing is right before you’re about to sign a new contract with a vendor, or when you’re about to make a large order.
Review pricing and revenue opportunities
You can also look at your accounts receivable and product line to see if you can make changes there. For instance, you can pursue these strategies:
- Adjust invoicing: Try speeding up your invoicing cycles so that payments come in faster.
- Payment incentives: Get creative and come up with some type of reward for faster customer payments, like early payment discounts.
- Promote high-margin products and services: Focus on marketing the products and services that bring in the most money, creating higher revenue.
Can you reduce payroll costs without laying off employees?
There are typically several options business owners can take before deciding to fire employees. While personal circumstances and applicable employment laws come into play, it's good to consider these alternatives:
- Freeze hiring and overtime: This should probably be one of the first steps you take. It's the adage to "make do with what you have." This allows you to evaluate your workload distribution and reduce labor expenses without lowering headcount.
- Reduce employee hours: This could be a temporary move that's in place only during the cash-strapped period you're experiencing. Or, you may decide to do it seasonally based on demand. Industries like retail, construction, and agriculture, as well as jobs like tax preparers and landscapers, are definitely busier and slower during certain parts of the year. One note of caution: hour reductions may impact employee morale and retention, so the move should be weighed carefully.
- Consider furloughs: Furloughs are less drastic than layoffs. When someone is furloughed, they remain an employee; their hours are just reduced or cut entirely. It's designed to be temporary, since there's an expectation you will call them back to their job.
Below are some of the key differences between furloughs and layoffs:
| Feature | Furloughs | Layoffs |
|---|---|---|
Employment status | Still employed | No longer employed |
Position status | Expectation to return | Position may be eliminated entirely |
Pay | Not paid (or in the case of reduced hours, only paid for those hours) | Not paid after termination |
Benefits | Healthcare insurance and some other benefits often continue | Usually end after termination |
Unemployment eligibility | May qualify depending on the state. No requirement to look for work. | Qualify |
Rehire process | No rehire needed | Must be rehired as an employee |
- Evaluate temporary compensation adjustments carefully: Reducing costs is not as simple as slashing compensation. There are wage and hour laws that have to be obeyed. Each state has its own rules, so it’s important to consult an HR or legal expert before making changes.
What happens if you can’t pay employees on time?
There are numerous consequences that come from not paying your workers what they're due. The Fair Labor Standards Act (FLSA) spells out what employers can and can't do if they're having trouble meeting payroll. This is important because there's a big difference when it comes to salaried (exempt) employees and hourly (non-exempt) employees. The FLSA also outlines federal minimum wage and overtime obligations.
State laws are often stricter, though. Many states have higher minimum wages than the federal minimum. Their requirements can also differ regarding payroll timing and frequency. For instance, some require biweekly payment, while others require semi-monthly payment. It's important to review the regulations for the state where your business is located.
If you miss payroll, employees can file federal or state complaints, which could lead to a government investigation. If you are found liable, you can be required to pay penalties, fines, and back wages. Plus, you'll most likely have to cover legal costs for your defense and, if the ruling is in their favor, the employee's legal costs.
Beyond that, your company will probably suffer reputational damage. That may be very hard to recover from, especially since it could affect client, vendor, and employee relationships. More than likely, there will also be significant employee turnover.
Signs payroll challenges are becoming long term
While every business goes through some temporary ups and downs, it’s good to be realistic about a true long-term problem. Persistent revenue declines, growing debt obligations, repeated payroll shortfalls, and the inability to restore profitability show that your current business model may not be sustainable.
In situations like that, you may need to make more drastic changes, such as layoffs. If you decide to do that, make sure to follow employment laws for workforce reductions. Final paycheck, notice obligations, benefits, and unemployment requirements for your terminated employees should all be reviewed and followed.
Can insurance help if a covered event leaves you unable to pay employees?
Many payroll difficulties stem from cash flow problems or declining revenue. Insurance generally doesn't apply in these situations. However, insurance can help when a covered event disrupts business operations.
Business interruption insurance, also known as business income insurance, helps pay for financial losses when your business can't operate due to a covered property claim. Payroll is one of the operating expenses covered under a business interruption policy.
For example, imagine you own a grocery store and a fire breaks out. The damage forces you to close the store for repairs. Your commercial property insurance would help pay for the renovation, computers, furniture and fixtures, inventory, equipment, and similar business property. But if the repairs take months, you won't have any revenue coming in during that time. That's where business interruption coverage steps in. It helps replace lost income and assists with ongoing operating expenses, including payroll.
Business interruption insurance is often included in a business owner's policy (BOP) as an endorsement. This is a convenient way to bundle your insurance into one package, including general liability, commercial property, and any other coverage your business may need.
What business interruption insurance doesn’t cover
It should be noted that the claim must result from direct physical damage to the property and be caused by a covered peril, such as a fire, wind or hail, or a burst water pipe. Damage resulting from vandalism is also often covered. However, some natural disasters, including earthquakes and floods, are typically excluded. You'll need separate policies for those risks.
Cyberattacks aren't typically considered physical property damage. So, if your business is the victim of a hack or ransomware exploitation, business interruption insurance will probably not apply. Instead, you'll need to rely on a cyber insurance policy.
There's also generally a waiting period before coverage begins. Usually, it's 24 to 72 hours after the triggering event. Coverage continues until you reopen your business or reach your policy limit, which is typically 12 to 24 months.
Does business interruption insurance cover government shutdowns and pandemics?
Even though government shutdowns and pandemics can interrupt business operations, they are generally excluded from standard business interruption insurance coverage. However, because of the impact of these events in recent years, the insurance industry has been reevaluating what qualifies as a direct physical loss, and interpretations may vary depending on your state.
New York has gone a step further. In 2024, a bill was signed into law allowing insurers to sell standalone business interruption insurance that does not have to be tied to physical damage. This means coverage can be triggered by business closures resulting from government mandates and pandemics.
How employment practices liability insurance (EPLI) can help protect your business
Because of added tension and stress, employee disputes often increase during financial hardship. These can include:
- Wrongful termination allegations
- Discrimination claims
- Retaliation allegations
- Wage-related disputes
- Breach of employment contract claims
Employment practices liability insurance covers your business against these types of claims. It handles the legal expenses for defending your case, such as attorney's fees and court costs. It will also pay out any settlements or judgments.
Of course, an EPLI policy isn't a substitute for legal compliance. Business owners must understand employee rights and abide by those laws. It does help, though, if you're facing employee-related claims.
Build a financial safety net before payroll becomes a problem
There are many proactive measures you can take to shield yourself from cash shortfalls during downturns. For instance, maintain an emergency cash reserve. Most businesses should aim for an emergency fund that could cover three to six months of their essential operating expenses.
You’ll also want to monitor your income forecasts regularly. This way you can pivot as soon as you notice a change, such as diversifying your revenue streams.
It’s also a good idea to review your insurance coverage for business continuity risks, such as:
- Business interruption insurance
- Commercial property insurance
- EPLI
- Other coverages relevant to your business
Get the right insurance to protect your company with Insureon
Insureon is here for your small business during the good times and the tough times. Our team of experts is trained to find insurance that can help you navigate through cash shortfalls.
Simply start a quote by answering a few questions, and you’ll instantly get options from the nation’s leading insurance providers. We’ll help you find the protection you need at the most affordable rates.
Coverage can begin within 24 hours, and you’ll get immediate access to an online portal where you can find your policy documents and request a certificate of liability insurance (CIO).
Sara Singh, Contributing Writer
Sara’s career has taken her across the writing spectrum. She started as a television news producer, then was hired as the marketing manager for a financial services firm. After working for the publisher of the world’s most widely circulated magazine, Sara went into the agency scene as a copywriter and finally served as the in-house content writer for a tech consultancy. Now, she freelances for a variety of clients so she can have the flexibility to do volunteer work and travel.
