What is payroll?
The basics for small businesses
As a small business owner, you have a lot to do. From managing the day-to-day operations to ensuring products are in-stock and doing the bookkeeping, you’ve got a lot on your plate. But one essential responsibility of running a small business is performing payroll. It’s not the most glamorous job, but without payroll your business can unravel quickly. So in this article, we’ll take a look at payroll – what it is, why it’s so important, and how it works. To start, let’s define what payroll means to business owners.
Payroll: The basics
As an employer, you know that you have to pay the people who work for you. That’s where payroll comes in. At its basic level, payroll is the act of compensating the employees who work for you. Usually, a business runs payroll for a specific period of time, which is usually every two weeks. During payroll, an employer calculates and then distributes employees’ wages.
But payroll is not just distributing wages to your employees. Payroll also consists of tax filing, calculating, taking out deductions for local, state, and federal taxes, as well as Social Security, unemployment insurance, and any voluntary deductions from employees. As you can see, payroll can get complex. Typically, someone in the Human Resources department of a company would be responsible for payroll. However, for those who don't have the capacity for in-house payroll management, there are plenty of companies who help businesses outsource payroll. Now that you know about payroll, let’s take a closer look at the main components of payroll.
As a business owner, paying your employees accurately and on-time is an essential part of doing business. If you have hourly employees, you’ll pay them for the hours they work in a given pay period. To calculate an hourly employee’s wages, you’d multiply their hourly pay rate by the number of hours they work in a given period. Keep in mind that for hourly (non-exempt) employees, you should also factor in overtime pay into payroll. States have various requirements, so it’s important to check with the state you do business in for this requirement and others.
If you have salaried employees, you’d pay them a fixed amount each pay period based on the number of pay periods in the year. To calculate this, you simply divide their annual salary by the number of pay periods to get their pay (before deductions) for each pay period. These calculations will give you the employee's gross pay, which is their pay amount before taxes and other deductions.
Calculating, deducting, and tracking benefits
The next key component of payroll is calculating and tracking benefits. These benefits include any paid time off (PTO), health insurance, sick days, retirement plans, and employee discounts. These employee benefits are all a form of compensation and should be accounted for when doing payroll. Some of these benefits, like 401K contributions, are pre-tax deductions and should be deducted from an employee's paycheck before being taxed.
Deducting and paying taxes
For employers, deducting payroll taxes out of an employee’s paycheck is another critical role. From the federal income tax to state and local taxes, you’ll deduct taxes from your employees’ paychecks based on their Form W-4, which states how much income tax withholding you should account for. One piece of this tax withholding is the Federal Insurance Contributions Act tax, or FICA tax. This tax funds the Social Security and Medicare programs in the United States, and both the employee and employer are responsible for paying half of this tax. For each part, the tax rate is 7.65%, for a combined percentage of 15.3%.
As a business owner, you’re responsible for submitting both the employees’ and the company’s tax contributions to Social Security and Medicare. As a company, you're also responsible for federal and state unemployment taxes. After these taxes and any other deductions, the remainder of the employees’ pay is their net pay, or their take home pay.
Filing reports with the government and providing reports to employees
The final component of payroll is filing reports to both the government and to your employees. Each person you employ must have a separate record of their pay for each pay period, known as a pay stub. These records are used at the end of the year to send to an employee as a W-2 (or 1099 for individual contractors). These forms are also due to the IRS for tax purposes. It’s important to keep detailed records throughout the year so that your filing will be smoother at the end of the tax year. It’s important to note that there may be other reports you need to file with your state and local governments based on your specific business situation.
In this section, we’ve looked at the main components of payroll and how each works. Now, let’s take a look at the payroll process.
A step-by-step guide to payroll
As you can see, payroll can be complex. But as an employer, you’re responsible for ensuring that payroll is accurate and sent to your employees in a timely manner. Based on the main components of payroll, let’s put together a process for your business to follow when processing payroll. The general payroll process can be broken down into the following steps:
- Determine your business’s payroll system: Decide how your business will handle payroll – either internally or externally.
- Define your payroll policies: Determine how you will pay your employees, independent contractors, and freelancers, and then develop policies for leave, attendance, and benefits.
- Collect and input employee data: Get all the necessary employee information, including bank account numbers and routing numbers for those employees who wish to have direct deposit.
- Implement time tracking: Introduce a method for employees to track their working hours.
- Review timesheets: Examine employee timesheets and check for discrepancies.
- Approve and submit payroll for payment: Confirm accurate timesheet recording, deduct any necessary withholdings (including all required government taxes), and then submit for payment.
- Save payroll records: Keep copies of payroll records for any adjustments you need to make and to have for your end-of-year reporting.
The payroll process seems pretty straightforward, but it can be complex. So much so that there are some common challenges that business owners like you face. Here are a few of the most common payroll challenges.
The challenges of payroll
Payroll can be difficult for a small business. Often, there are issues that business owners run into that make payroll even more of a challenge than it needs to be. Here are some of the most common payroll challenges businesses face:
- Manual payroll processing: While it can seem like the easiest way to perform payroll, using a simple payroll method like a spreadsheet can be a nuisance. That’s because it’s time consuming and prone to human error. So as your business grows, the risks of payroll mistakes and inaccuracies grows exponentially. With no way to automate the process, this method can also eat up a lot of your valuable time.
- Staying up to date with rules and regulations: Another big challenge for small business owners is staying in compliance with all the employment rules and regulations. While you’re running your business, it can be tough to follow along with the latest laws. Failing to keep up with these changes can be costly, as your business could face significant fines and penalties.
- Keeping your records: Another struggle for small businesses is keeping track of employee records. According to the Fair Labor Standards Act (FLSA), records of employee earnings must be kept for at least three years from the date of the last entry.
- Under or over payments: Another headache when running payroll can arise from mispaying employees. Whether it’s paying them less than they earn or more, mispaying can be troublesome, especially if it’s an overpayment issue whereby employees would likely have to repay the company or receive less pay in future checks until the discrepancy has been corrected. These mispayments can also impact the end-of-year accounting and W-2 processing. These are great reasons why automating payroll can help keep your business moving.
- Misclassifying employees: The last big challenge for small businesses when it comes to payroll is misclassifying employees. This can happen if you employ contractors, full-time employees, or part-time employees. Again, this misclassification can be a costly fix when it comes to payday and end-of-year payroll reporting.
As you can see, these payroll challenges can take a big toll on your business. But, one of the best ways to eliminate these payroll challenges is to find a payroll solution that can fit your business. Here are two of the most popular solutions:
- Payroll service: This option utilizes a third-party company to run your payroll. These payroll service providers offer other financial services to businesses, so you should check with them 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: This option uses special accounting software to completely automate your payroll. These software solutions can minimize human error, perform payroll reports, and keep track of your employees’ timesheets. 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 Human Resources software) your business uses. It can even supply employees with an employee self-service portal that gives them quick access to their payroll records.
Payroll is necessary for your business, but it can also be time-consuming and complicated. In this article, we’ve talked about why it’s important and the basic steps involved in running payroll. For small business owners like you who want to focus on running their business, outsourcing payroll is a great option to combat the payroll challenges we’ve discussed while working with experienced payroll professionals. With someone else responsible for running your payroll, you’ll be free to focus on what you do best – running your business.
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