How To Handle Payroll: Essential Small Business Guide

Paying your staff correctly is your legal responsibility as a business owner, so it’s crucial that you get it right.

However, getting your head around the complexities of payroll can quickly become confusing. That’s why a good-quality software or a reliable payroll provider can help simplify this process and keep you on track with wage, tax and reporting obligations.

In this article, we’ll guide you through everything you need to know to pay your staff correctly. From first registration to staying on top of your HMRC reporting, here’s how to get your payroll right from start to finish.

💡Key takeaways

You must register with HMRC as an employer up to one month before paying employees.
When setting salaries, you should consider affordability, the role’s responsibilities, the candidate’s experience, and industry benchmarks.
A good online payroll software can help ensure timely payments and compliance.
You must provide payslips to employees with details on gross wages, deductions, and net pay.
You’ll need to submit a Full Payment Submission (FPS) to HMRC every payday to report employee pay and reductions.
You’ll need to notify HMRC of any significant changes in employee status (e.g. new hires, leaves of absence, or tax code updates).

In this guide, we'll cover the following steps:

1. Register online as an employer
2. Calculate employee salaries
3. Choose a payroll software
4. Choose a pay model
5. Decide on a commission structure
6. Produce payslips for HMRC
7. Report employee pay and pay taxes
8. Report relevant changes

1. Register online as an employer

As soon as you start hiring employees, you’ll have to register yourself as an employer with HMRC up to one month before you pay your new hires.

It’s important to note that the process can take up to 15 working days. You should register as soon as you know you’ll be hiring staff, as you can’t register more than two months before you start paying people.

After registration, you will receive a Pay As You Earn (PAYE) number, which you’ll need for running payroll and reporting to HMRC. You’ll also be sent an activation code for PAYE Online within 10 days by post, which you must activate within 28 days of the date on the letter.

Are there any exemptions?

In some cases, you may be exempt from registering. This includes:

Having no employees: if you’re not hiring or paying anyone through PAYE (for example, you’re a sole trader without staff), you don’t need to register.
Hiring voluntary workers: volunteers who aren’t paid don’t require registration. However, if you reimburse any expenses, you may need to check with HMRC.
You’re a director without pay: you may not need to register if you’re a director and not drawing a salary. But if you pay yourself, registration is required.
Hiring casual or seasonal workers: for very short-term workers (for example, those that do a day’s work) where no tax or National Insurance Contributions (NICs) are deducted, registration may not be needed.

Most limited companies can register online with HMRC in just a few simple steps. You can get started by going to the government’s employer registration page.

2. Calculate employee salaries

Determining the right salary during the interview process can be tricky. The aim is to get the right balance between what works for the company and what meets candidate expectations.

When it comes to deciding this, here are a couple of things you should consider:

Affordability: think about the gap this new hire will fill, how valuable it is to your business, and what impact the expense will likely have.
Evaluate the position: does the role require specialist knowledge or technical training? How much responsibility will they have to make decisions that affect the business?
The candidate’s experience: is the candidate fresh out of university, or do they have years of experience or a specialist degree?
Industry benchmarking: many professional organisations share pay surveys regularly, giving you a good reference point for salary scales. These are usually available online for free, such as Hays Salary Checker and Reed’s UK salary guides.

3. Choose a payroll software

Payroll software makes it easier to pay your staff accurately and on time, while staying compliant with tax and reporting requirements.

The other benefits of a good payroll software include saving time on admin, reducing the risk of mistakes, and keeping employee records in one place.

However, with so many options out there, it can be difficult to choose the right payroll software for your business. To help you out, we’ve put together a comparison table of the best small business payroll software available, based on thorough market research and analysis:

Swipe right to see more

FEATURED PROVIDER	BEST ALL ROUND
Provider QuickBooks	Provider Staffology by IRIS	Provider Sage Payroll	Provider Xero	Provider Moorepay
Cost £3.30-£11.50/mo plans* + 0.50/mo for payroll features *For the first six months	Cost £35 for up to 19 employees £1.75 per payslip for 20-50 employees Pricing on request for 51+ employees	Cost £10-£30/mo plans + £2-£6/mo for additional employees	Cost £33-£59/mo plans* *Currently 90% off if you buy before 31 January	Cost Provides personalised quotes after assessing business needs
HMRC compliant	HMRC compliant	HMRC compliant	HMRC compliant	HMRC compliant

Can’t afford payroll software?

If you’re just starting out and can’t yet afford commercial payroll software, you can use HMRC’s Basic PAYE Tools.

However, it does have its downsides — like not being able to produce payslips — and it’s really only suitable for businesses with fewer than 10 employees.

4. Choose a pay model

Depending on the type of business you own or what sort of role you’re recruiting for, there are many different types of pay you might want to consider offering employees.

Choosing the right pay model is important because it affects how you manage your budget and attract talent. It also gives everyone a clear idea of how pay works and what to expect.

Here’s a quick breakdown of the most common types of pay employees can receive.

Type of pay	Description
Salary	Staff are paid based on the number of hours they would work in a year.
Hourly rate	Staff are paid for a set number of hours they’ll work in any given week.
Commission	Most common in sales and recruitment roles, employees receive a share of the sales they make. While commission roles often include a basic salary/wage, this is not always the case.
Piece work	Employees are paid a set amount for every unit they produce – common in the manufacturing and textiles sector.
Tips	Tips received from a customer directly, such as in a restaurant, do not form part of the employee's pay, as they are the property of the employee and are not paid by the employer. However, you can treat tips to your staff as normal pay if they’re paid into your till – this includes tips added to your customers’ card or cheque payments.

Note: The type of pay you’ll be offering new employees should be explicitly stated in their contract of employment.

Additional pay and reductions

On top of their regular pay, there might be other payments you’ll need to make and keep records of. These include:

There are also three legally required deductions you’ll need to work out for employees, which are:

Income tax
National Insurance
Pension contributions

Other deductions that may apply include student loan repayments, Payroll Giving donations and child maintenance payments.

Paying freelancers and self-employed staff

Freelancers, self-employed people, or contractors take care of their own National Insurance contributions (NICs), sometimes through an umbrella payroll company, so you don’t need to handle tax or NI deductions for them.

Freelancers also don’t need to be enrolled in the company pension scheme and aren’t entitled to things like paid holiday, sick leave, or other employee benefits — unless their contract says otherwise.

However, you must follow rules and regulations when hiring contractors. Additionally, you should also draw up a contract that sets up exactly what is expected from both parties, and can protect you in the event of not delivering the agreed work.

Finding your employee’s tax code

To make tax deductions on your employee’s pay, you’ll need their tax code. If you don’t know what this is, you can use the government’s tax code calculator to get an estimate based on their personal details and income.

For most employees, the information you need should be on the P45 form they received when they left their previous job or stopped seeking Universal Credit/Jobseeker’s Allowance. While it’s not a legal requirement, having this information makes it easier to get their tax code right and avoid issues later down the line.

If this doesn’t apply, they’ll need to complete a new starter checklist, which you can find on the government website.

Working out your employees’ National Insurance

Next, you’ll need to figure out how much National Insurance the employee needs to pay, which depends on how much they earn and what category (or NI letter) they fall under. Simply check the table below to see which criteria apply.

Category letter	Employee group
A	The majority of employees; anyone who doesn’t fit into the categories listed below will have a National Insurance letter of A.
B	Married women and widows entitled to pay reduced National Insurance.
C	Employees over the state pension age.
J	Employees who can defer National Insurance because they’re already paying it in another job.
H	Apprentices aged under 25.
M	Employees aged under 21.
Z	Employees under 21 who can defer National Insurance because they’re already paying it in another job.

Source: gov.uk

5. Decide on a commission structure

When considering commission rates for employees, think about what you can afford, what sort of product/service you’re selling, and what sort of company culture you want to promote.

If you’re considering setting up a commission structure, you’ll need to understand some basic commission models so you can choose one that fits your business goals and keeps your team motivated.

Here’s a breakdown of the most common commission models, including their advantages and disadvantages.

Base salary + commission

This is where employees receive a fixed base salary along with commission payments based on their sales or performance. It gives employees the security of a steady paycheck while also motivating them to perform better, since commissions kick in when they hit or surpass their targets.

Pros

Offers financial security, even during slow periods
Encourages employees to work harder and aim for goals
Attracts talent as many candidates prefer the balance of reliable pay and earning potential

Cons

Employees may be less driven than in commission-only roles
You pay both a salary and commissions, which can become costly
Requires good systems to accurately track and pay commissions

Commission only

Commission only means employees earn no base salary but receive 100% of their pay from commissions based on sales or performance. In other words, their earnings depend entirely on how well they perform.

Pros

High earning potential if employees can meet targets
Employees are more motivated to perform well
No salary costs for employers

Cons

Employees may face periods of little to no income (such as a slow sales month)
The lack of guaranteed pay can lead to stress and burnout
Difficult to attract employees who prefer financial stability

Tiered commission

A tiered commission is when an employee earns a higher commission rate once they hit certain sales targets or thresholds. For example, they might earn a 5% commission on sales up to £10,000, and then 8% on anything above that.

Pros

Employees are motivated to exceed their targets to earn higher commission
Helps recognise and reward those who go above and beyond
Gives employees clear targets, helping to improve focus and productivity

Cons

Having multiple tiers can make calculations and tracking more complicated
Risk of too much focus on hitting tiers and ignoring long-term goals
Employees may feel pressured to constantly exceed targets

Bonuses with commission

In this case, employees can earn commission, plus additional bonuses for hitting specific KPI targets or achieving company goals, such as meeting a sales target or contributing to team success.

Pros

Motivates employees to hit targets and work towards company-wide goals
Encourages teamwork and helps build a collaborative environment
Offers an additional reward on top of commissions, which can boost morale

Cons

Managing both commission and bonuses can get complicated
Employees might get confused if goals for commissions and bonuses aren't well-defined
Employers may end up paying more overall if commission and bonus targets are regularly met

Commission with draw

This involves employees receiving a guaranteed “draw” (A.K.A. an advance) against future commissions. This means that if the employee doesn’t earn enough commission to cover the draw, they may owe the difference. On the other hand, if they earn more than they draw, they keep the extra money.

Pros

Employees get a guaranteed minimum income
Employees can earn more than the draw if they exceed targets
The security of the draw can help attract and retain employees, especially in commission-heavy roles

Cons

Can lead to debt if employees don't earn enough commission
Risk of employer paying out a lot in draws without seeing return on commission
Tracking draws can be more complicated than straight commission models

6. Produce payslips for HMRC

As an employer, you are legally required to provide your staff with a payslip on or before their payday.

Whether you produce the payslip online or send it through the post, the payslip must include the following information:

The amount paid before any deductions (“gross” wages)
The amount taken for deductions (e.g. income tax or National Insurance)
The amount paid after deductions (“net” wages)

Image source: Reed.co.uk

There’s a lot of information on a payslip, so it’s easy to get confused. However, some key factors to note are:

The tax code in the top right corner (under deductions).
The employee’s National Insurance number in the bottom right corner.
The running totals section (bottom left), which shows how much has been paid by both parties in various categories since both the start of employment and the start of the current tax year.

7. Report employee pay and pay taxes

Every payday, you’ll need to send a Full Payment Submission (FPS) to tell HMRC what you’ve paid your employees and what deductions you’ve made.

An FPS has to be sent on or before your employees’ payday, even if you pay HMRC quarterly instead of monthly. You’ll also need to enter the following information into your payroll software:

Employer registration details (such as your PAYE reference or Accounts Office Reference)
Employee personal details (name, address, NI number, date of birth, gender, etc.)
Employment information for each employee (starter and leaver information, and whether they are a company director)
Year-to-date figures for each employee listed (tax and NI contributions)
Figures for the relevant period for each employee (including payment date, gross pay and the amount deducted for NI and tax)

If you need to, you can send an FPS early, like if your payroll team is off on holiday. You’ll also need to send a corrected FPS if any relevant information changes, such as if an employee leaves or changes tax code.

8. Report relevant changes

Employee information changes frequently, and once again, you have a legal responsibility to inform HRMC of these changes.

If any employee details change, you must send details of new and updated information to HMRC via an FPS form. You’ll need to inform HRMC if an employee:

Joins the company
Leaves the company
Takes a leave of absence
Starts receiving a workplace pension/joins or leaves a contracted pension
Changes their home address
Becomes a director of the business
Reaches State Pension age (currenly 66 in the UK, but is set to increase to 67 between 2026 and 2028)
Goes to work abroad
Goes on jury service
Passes away
Turns 16
Is called up as a reservist
Changes gender

Payday changes

To change your business’s payday, there are a few things you should do to stay compliant and keep things running smoothly. This includes:

Checking employee contracts: if your original payday is stated in the contract, you may need to get a written agreement from employees to make a change.
Giving notice: give your staff plenty of notice—ideally in writing—so they’re not caught off guard. Be clear about when the old payday ends and when the new one begins.
Updating your payroll software: adjust the settings in your payroll system to reflect the new payday. Make sure everything aligns correctly, including tax periods and pay calculations.
Letting HMRC know: you don’t need to formally notify HMRC about a new payday, but you must report the correct pay date in your FPS each time you run payroll.

If you need help working out National Insurance after you’ve changed payday, you can go to the government website for further guidance.

Conclusion

Handling payroll doesn’t have to be an admin headache. With the right tools and a solid process in place, it can become much more manageable.

Whether you’re hiring your first employee or building a larger team, staying on top of employment registration, pay structures, tax deductions, and reporting obligations will help you avoid costly mistakes down the line.

By making use of HR and payroll software and staying informed about HMRC requirements, you can quickly make payroll an easy part of your business operations.

A guide to payroll: how to pay your employees right

Our experts

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In this guide, we'll cover the following steps:

1. Register online as an employer

2. Calculate employee salaries

3. Choose a payroll software