What is payroll? A guide for small businesses

Payroll can be defined as the process of paying your employees.

It differs from a salary in that it is an administrative process using a particular system to ensure all your employees are paid accurately and fairly. A salary is the exact amount an employee is paid depending on the terms of their contract.

Payroll is essential to any business, and in this article we’ll look at the reasons why and offer expert advice on how best to run your company’s payroll.

What is payroll?

Payroll was originally defined as a list of employees within a company and the amounts they are due to be paid. It has evolved over time to now refer to the wider process of paying employees, which involves a lot more than just wages.

It typically also involves administrative procedures, such as updating employees’ bank details, actioned by a team of payroll professionals.

Payroll can be managed in a number of ways, such as:

• In-house, with your own dedicated payroll team
• Via an outsourced payroll service provider
• With the help of payroll software

As your business grows you will inevitably hire people to work for you. When this happens, the importance of understanding and implementing payroll cannot be understated.

This is because payroll is not just a system that keeps track of the amount you need to pay employees and employer wages. It has many other purposes, some of which are essential if you want to run a business lawfully.

How does it work?

In order to process payroll, you need to carry out the following steps each tax month. Tax months run from the 6th of one month to the 5th of the next:

1. Record employees’ pay – including their salary and any statutory sick pay or holiday pay
2. Calculate deductions from their pay – including tax, national insurance and any student loan payments. Payroll software typically does this automatically
3. Calculate the employer’s (your business’) national insurance contribution – this needs to be paid on earnings above £184 a week
4. Produce payslips for each employee – these can be generated by most payroll software or your payroll service provider
5. Report your employees’ pay and deductions to HMRC – this is known as a Full Payment Submission (FPS)

What is payroll needed for?

Record keeping

Payroll is a useful tool for tracking payment records. It can be used to calculate how much each individual employee has made during their tenure at your company – which is vital for forecasting and budget planning.

Payslips provided through payroll can also be used to assess the amount of tax, NI, or pension contributions deducted from an employee’s wage. They’re also requested when people are applying for mortgages or loans, as proof of employment and income.

Note that it’s important to keep records of pension contributions amongst other deductions.

Paying employees accurately

Do not underestimate the importance of payroll – it is a necessity if you want to pay your employees accurately and lawfully. This is because whether you’re using in-house payroll software or outsourcing to a service provider, everything will be done by the book, and all deductions will be properly calculated.

Visit our dedicated how to pay your employees page for more information.

Remaining HMRC compliant

In order for a business to operate lawfully in the UK, HMRC must be notified when a new employee is hired, and all employees must pay taxes depending on their assigned tax code. Payroll is important because it automatically sets and deducts taxes for each employee, and by managing payroll, you can keep up to date with any changes to HMRC rules and regulations.

Calculating other deductions and contributions

Payroll software will help you calculate things like national insurance contributions. It can even be set up to automatically deduct for a workplace pension scheme, which you’re required to offer by law.

Payslips will look different depending on how employees are paid. But regardless of this, they must always include gross and net pay.

Gross pay is an employee’s total pay, whilst net pay is the amount the individual actually receives after tax and any other deductions.

Paying your employees based on their hours

For staff members on a salary, all you need to do is ensure that they are working their contracted hours. The amount they get paid monthly will not change unless they receive bonuses, commission or sick pay.

In regards to hourly paid employees, their pay may differ week on week depending on the number of hours they’ve worked.

It is important, not only for payroll and tax purposes but also for your business’ finances, that you keep a record of how many hours each employee has worked during each pay period.

A lot of businesses typically have a rota in place to pre-determine the hours each employee will work, and a clock-in, clock-out system to confirm this.

Tax and deductions

Every employee must pay tax and national insurance before receiving their net pay. The total payment made by your business is the taxable gross amount, and the deductions are then made before the employee receives their pay.

It is your responsibility as the employer to calculate and arrange these deductions. If you don’t do this correctly or miss any HMRC deadlines, you could risk a hefty fine.

Gross pay deductions are always tax and national insurance contributions. However, there are other additional deductions that are conditional payments dependent on an individual’s circumstances.

Additional deductions and payments

Some employees will be making payment contributions towards other things, while others will be receiving additional payments. These can include:

• Pension scheme contributions – as a registered business you should be offering all employees a workplace pension scheme that they can contribute to, and it is your responsibility to ensure this is set up correctly in payroll. It is also important to mention that an employee can opt in or out of a scheme at any time – and this must also be reflected in payroll.
• Student loan repayments – once an employee reaches the payment threshold, they must start repaying their student loan. This can be taken out of their salary/wage.
• Commission – in some industries, particularly sales, many of your employees may work on a commission basis. This means each payment may be different depending on the amount of commission they’ve earned – and it is your responsibility to pay this correctly.
• Bonuses – unlike a commission, bonuses are typically a pre-agreed amount paid annually after a milestone or target has been reached.

How to run payroll

Now for the important part: deciding the best way to run payroll for your small business.

There are three primary ways, each with its own pros and cons, for you to manage your payroll:

• In-house, manually with your own dedicated payroll team
• Via an outsourced payroll service provider
• Using payroll software

As payroll experts at Startups, we recommend you run payroll either by outsourcing (at least partly) to a trusted payroll service provider, or by managing it all in house using the latest payroll software.

Of course, you could choose the traditional method of managing payroll manually (by hand) – but there are a lot of issues with this method, which we will discuss.

Using a payroll service provider

This is a popular option because it allows smaller businesses that don’t have the capacity to hire a dedicated payroll team to outsource all payroll duties to a service that does.

Essentially, by outsourcing your payroll you hand all of the responsibility over to a service provider, such as IRIS or Sage. They will look after all of the administrative tasks and processes to ensure you remain HMRC compliant, and will make sure your staff are paid accurately and on time.

The great thing about outsourcing payroll is that you have the flexibility to choose how involved you want your service provider to be.

The majority of payroll service providers offer fully managed, partly managed, and administrative level plans to support you according to your business needs.

Pros and cons of outsourcing payroll:

Payroll software

Payroll software is an application that assists you in organising, managing and automating employee payments. It can either be an on-premises or cloud-based solution, but is typically cloud based.

The role of payroll software is to ensure you remain compliant with tax regulations and the requirements set out by HMRC. It also streamlines and automates payroll processes, so you can save time and reduce the cost of employing a large team of payroll professionals and administrators.

We recommend Moorepay, a highly experienced and trustworthy provider, or Rippling, an intuitive software with transparent and affordable pricing.

Payroll software is great because it doesn’t involve the huge expense of outsourcing to a service. However, even if you are managing your own business’ payroll using software, you will need to employ at least one payroll professional/administrator to be in charge. You’ll usually need to pay them between £20,000–£45,000 per year.

Payroll software pros and cons:

Manual payroll

Some businesses opt to run payroll manually, meaning they do everything by hand and keep physical copies of all records and files.

This is a very traditional, old school method of managing payroll, and it can actually be quite expensive and inefficient.

In order to manage your payroll team entirely in-house, you’ll need to employ at least two to four payroll specialists, and an additional payroll administrator depending on the size of your business.

This can prove incredibly costly, and it will be far cheaper to either outsource your payroll entirely or set up payroll software and employ one payroll specialist to manage things in-house.

Manually submitting payroll can also be time consuming, especially for larger businesses.

Pros and cons of manual payroll:

Need a quote?

Now you’ve understood what payroll is and the best ways you can manage it for your business, it’s time to shop around for the best options on the UK payroll market.

Whether you are looking to outsource your payroll or get going with payroll software, you’ll want to receive personalised quotes from some of the best providers in the industry.

The best way to do this is by using our free, easy-to-use payroll cost comparison tool, which can provide you quotes from the likes of IRIS, Moorepay and ADP.

It is incredibly simple to use, has zero obligations on your part, and is guaranteed to save you time and money.