How to Manage Payroll for Your Small Business
What you need to know as a business owner
When it comes to running your business, there’s a lot to keep in mind. One of the biggest business needs is making sure that you pay your employees on time every payday. And while processing payroll can be time consuming, there’s a few different ways to streamline payroll at your small business. So, in this article, we’ll take a look at running payroll for your business, including the entire payroll process. Then, we’ll take a look at some of the ways you can maximize efficiency with your small business payroll. To start, let’s talk about payroll management.
What is payroll management?
As a business owner, chances are you’ve heard of the term payroll. At its basic level, payroll is the act of compensating the people who work for you – your employees. Usually, a business runs payroll for a specific period of time, with the most common occurring every two weeks. When you run payroll, you’re calculating and distributing employees’ wages.
But payroll management is not only distributing wages. Payroll management is the entire process of running payroll, from paying employees to tax filing, calculating and taking out deductions for local, state and federal taxes, Social Security, Medicare, unemployment insurance, and any voluntary employee deductions. The payroll management process also includes maintaining records of every transaction your business makes.
As you can see, payroll can become complicated pretty quickly. And while your business’s growth is a positive thing, it can complicate your payroll process even more. That’s why many businesses find efficiencies in hiring a dedicated employee or team to specifically handle payroll as part of their Human Resources (HR) team. Businesses also utilize payroll software programs or outsource payroll to third-party partners. It’s important that your business runs payroll accurately and in a timely manner, and using these payroll tools can help you accomplish this.
No matter how you choose to handle payroll, it’s important to understand the steps involved in payroll management. So, in the next section, we’ll describe each in detail.
Payroll management: the steps
Knowing the steps of payroll management is important for business owners like you, even if you don’t end up managing payroll yourself. So, let’s take a look at the steps involved in payroll:
Determine payroll policies and set up payroll
One of the first steps you’ll take when it comes to payroll is defining your business’s policies. These policies include how you’ll pay your employees and how often. While many businesses complete payroll every two weeks, your payroll needs may be different and you might elect to pay on a weekly, bi-weekly, or semi-monthly basis. If you haven’t done so already, you’ll need to define your policies for paid time off, attendance and time tracking, and employee benefits, as each of these factors into payroll.
To set up payroll, you’ll need to obtain an Employer Identification Number (EIN) from the federal government. This nine-digit number is necessary for you to file your business taxes. You may also elect to set up a separate payroll bank account, which can help speed up the payroll reconciliation process. Finally, your business should register for an Electronic Federal Tax Payment System (EFTPS) account. This account is necessary to pay federal taxes.
Gather employee data
The next step in the payroll process is gathering all the necessary employee data. Keeping track of employee information is paramount to running accurate payroll. Whether you’re collecting all of this data yourself or you have an employee self-service portal that gives employees the ability to add or change things like their address or deductions, accurate data helps streamline your payroll process. Each employee will need to fill out the following information during the onboarding process:
- Form W-4 for federal withholdings
- State income tax forms (which vary by state)
- Form I-9 to verify employment eligibility
During the onboarding process, it’ll also be helpful to collect any bank account information from employees in order to set up direct deposit, as this is the most common and streamlined way for employees to receive their paychecks.
Calculate gross pay
The next step in the payroll process is to calculate the gross pay of each employee during the given time period. For salaried employees, this is a straightforward calculation. Simply take their annual salary and divide it by the number of pay periods in a year. For example, let’s say you employ someone for $100,000 per year. Assuming you have 26 pay periods in the year, the calculation would look like this:
Total salary / pay periods = gross pay
$100,000 / 26 = $3,846.15 gross pay
Now, if you employ hourly workers, the calculation is a bit more complex. For these hourly, non-exempt workers, you must pay them overtime in accordance with the Fair Labor Standards Act (FLSA). That means if they work overtime, you must pay them time and a half for all overtime hours.
Let’s say you employ an hourly worker at $15 per hour, and during the two-week pay period, they worked 84 hours. To figure out their gross pay, the calculation looks like this:
[Total hours worked (up to 40 per week) x pay per hour] + [1.5 x overtime hours worked x pay per hour]
[80 hours x $15] + [1.5 x 4 x $15] = $1,200 (regular pay) + $90 (overtime pay) = $1,290
As you can see, there’s an extra step required for hourly employees who work overtime. Manually tracking hours can be cumbersome for small business owners like you. That’s why many businesses invest in HR software that has time tracking integration, making it easy to know exactly how many hours your employees work in a given period.
Payroll taxes and deductions
There are three types of payroll deductions – pre-tax, tax withholdings, and post-tax. As a business owner, you’ll need to know each. Net pay is the remaining amount of money after you subtract all of these deductions from your employees’ paychecks.
These deductions include contributions to health insurance and some retirement plans and decrease taxable wages. They also reduce a business’s federal income tax liability, but don’t decrease all payroll taxes. For example, FICA taxes use gross pay to calculate Medicare and Social Security taxes.
As an employer, you’ll need to withhold a portion of your employees’ paychecks. These withholdings can include:
- Federal income tax withholding.
- Local and state tax withholding.
- Employee half of Medicare and Social Security taxes (FICA) – both the employee and employer pay 7.65% of the employee’s gross income to fund the Medicare and Social Security programs.
- State unemployment tax (SUTA), depending on the state.
- Additional Medicare taxes for high-earners.
Take note that these withholdings are from the employee’s paycheck and not what you pay as the employer. You have to pay some taxes, and we’ll take a look at those in the next section.
After subtracting taxes for employees, you’ll need to subtract any post-tax deductions. These deductions can include wage garnishment, life insurance plan contributions, and Roth 401(k) contributions.
Calculating employer payroll taxes
The next step after subtracting all of the employee deductions is tax calculation. As a business, it's necessary to calculate and subtract your tax responsibility as a business. Employers are responsible for the following payroll taxes:
- Federal unemployment tax (FUTA) – 6% of an employee’s salary up to $7,000 of eligible income per employee. Depending on the state your business operates in, the IRS could give you a credit of up to 5.4% when you file your Form 940.
- State unemployment tax (SUTA) – this tax rate varies from state to state, based on a variety of factors.
- Employer half of Medicare and Social Security taxes (FICA) – as stated earlier, both the employee and employer pay 7.65% of the employee’s gross income to fund the Medicare and Social Security programs.
- Local taxes – variable based on the local rules and regulations.
The next important step in managing payroll is payroll reconciliation. This is the process of checking your work to make sure your expected payroll and actual payroll match. Getting into the habit of reconciling payroll is good practice – for each pay period, before filing quarterly taxes, and before sending your employees their Form W-2s.
To reconcile your payroll, review employee pay rates and take a closer look at anything that looks off (whether higher or lower than expected). Also, for hourly workers, check overtime, and tips, if applicable. You’ll also want to check for errors in withholdings or deductions, calculated hours, and total pay for the period. Manual entry of payroll information can cause these errors; however, payroll software can oftentimes flag some of these potential inaccuracies. Most businesses elect to check their payroll two days before they run payroll, but for more complicated payroll needs, give yourself more time to review.
Prepare payroll journal entries
When you run a small business, you know the importance of accounting for every penny. And that’s what this next step is all about. You’ll need to prepare a payroll journal entry for your accounting records. Often, payroll software can automatically generate journal entries, and some payroll software can even integrate with accounting software for a direct import.
In the payroll journal entry, you’ll include all the costs to process payroll: wages, employee- and employer-paid payroll taxes, and payroll deductions. Depending on your business’s accounting method, these payroll journal entries will vary in complexity. For those businesses that use accrual accounting, payroll journal entries may be more detailed than those who use cash-basis accounting.
Pay your employees
After these steps are completed, you’re ready to cut checks to your employees on payday. Whether you pay employees by physical check or send pay via direct deposit, you’ll want to make sure that you attach a pay stub to each paycheck. The pay stub is the proof of their work, and shows employees how you got to the final paycheck amount. These details can help an employee double check that they’re receiving the correct paycheck amount or gain a better understanding of where their money is going.
Make tax and benefit payments
Once you cut the checks to your employees, it’s time to send off the tax and benefit payments. If your business utilizes a tax software, these payments should be made on your behalf. If not, you’ll need to pay taxes to the appropriate entities. And for businesses that offer health benefits and retirement plans, you’ll want to make sure you’re sending them the correct amounts as well. Paying these providers on time is essential to ensure that no lapse of coverage issues arise.
Generate and store appropriate documentation
The final step in the payroll process is to generate and store the appropriate records. These include all tax filings and tax-related documents. In fact, according to the IRS, businesses must keep employment tax records for at least four years. The U.S. Department of Labor and FLSA require that your business keep employee payroll records for at least three years. Your state may also have additional requirements for recordkeeping.
When it comes to storing records, you’ll want to make sure to keep all of your data organized. The easiest way to organize is by fiscal year. You’ll also want to make sure that these records are safe from threats. If you choose to outsource your payroll, be sure that your payroll partner is maintaining your records. Another great thing about payroll software is that electronic records are already available. However, even with electronic records, it’s good practice to store a copy on a separate device or platform.
Now that you’ve seen the full payroll management process, let’s take a look at the ways your small business can manage your payroll.
Managing your payroll
When it comes to payroll options, there are a few systems your small business can consider. As you look to develop a payroll process for your business, it’s important to weigh the pros and cons of each option to find the best payroll system for your needs based on functionality, customer support, and pricing. Here are four of the most common payroll management options:
- In-house payroll: This option is the most economical and involves a payroll process that an owner or employee must complete manually every pay period. This can work for small businesses or startups and is generally more economical than other options. However, it can be difficult to sustain these processes as your small business expands and your team grows.
- Full-time accountant: This option outsources payroll to a single accountant who has the financial expertise to run your payroll and even provide advice and insights to you. Your business could either hire this person for an internal role or outsource it to a contractor who would handle your payroll for you. By hiring a single person, you get the expertise at an economical cost for your business.
- Payroll service: This option utilizes a third-party company to run your payroll. Payroll providers offer full-service payroll solutions and sometimes offer other add-on financial services to businesses. Check with these providers to see about bundling multiple services for your business. Integrating your financial services with one provider is a great way to keep all of your financial information in one place. This makes it easy to compare company revenue and labor expenses, among other things. If you’re already working with a financial services provider, they may give you a discount if you add their payroll services. As always, it’s best to check with your provider for their options for your business.
- Payroll software: The last option uses special accounting software to completely automate your payroll. These software solutions can minimize human error, perform payroll reports, and keep track of an employee’s hours with timesheet functionality. Payroll software can also help you keep all of your payroll data in one place while offering you a whole host of payroll features. Many software options offer intuitive interfaces that make payroll management easy. Much like using a payroll service, payroll software tends to integrate well with other software (like onboarding or HR solutions) your business uses. It can even supply employees with user-friendly HR tools like time tracking and an employee self-service portal that gives employees quick access to their payroll records, even through a mobile app.
As you can see, there’s a lot to consider when running payroll at your company. It’s more complex than you might think at first glance. And if you don’t want to focus your time on it, outsourcing payroll is a great solution for business owners like you. But, if you’re going to take it on yourself, you now have the tools to build a payroll management process that works for you.
Ready to work with a payroll partner who can help you manage your payroll?
Heartland is the point of sale, payments and payroll solution of choice for entrepreneurs that need human-centered technology to sell more, keep customers coming back and spend less time in the back office. Nearly 1,000,000 businesses trust us to guide them through market changes and technology challenges, so they can stay competitive and focus on building remarkable businesses instead of managing the daily grind. Learn more at heartland.us.