What payroll means
Payroll is the process of paying the people who work for you correctly and on time, while meeting the legal duties that come with it. It includes working out what each person has earned, applying required deductions, paying them, passing certain amounts to authorities, and keeping records.
This article is a general introduction only. It is not legal, tax or accounting advice. Payroll rules differ widely by country, state and locality, and mistakes can lead to penalties. Before you run payroll, speak to a qualified accountant, payroll professional or the relevant government agency about what applies to you.
Core terms
- Gross pay. What the employee earns before deductions, such as wages for hours worked or a salary for the period.
- Deductions and withholding. Amounts taken from gross pay. Some are required by law, such as income tax and social contributions in many places, and some are voluntary, such as a retirement contribution an employee chooses.
- Net pay. What the employee actually receives after deductions.
- Employer costs. Amounts the employer pays on top of wages, which may include employer taxes or contributions, insurance and leave. These are not taken from the employee’s pay.
- Pay period. How often people are paid, such as weekly, every two weeks or monthly. Some places set rules about this.
A simple hypothetical
Suppose an employee earns $20 an hour and works 10 hours in a pay period. Gross pay is $20 x 10 = $200. If, purely for illustration, a total of $30 were withheld for various required deductions, net pay would be $200 minus $30, which is $170. The real amounts depend entirely on your location and the employee’s situation, so these numbers show only how the pieces relate.
The general steps of a pay run
- Collect the information. Before the first payment, you typically need the employee’s identifying details, tax-related forms required locally, bank details if paying electronically, and proof of the right to work where that applies.
- Record the hours or salary. Track time accurately for hourly staff, including overtime and leave, as local rules require.
- Calculate gross pay. Apply the agreed rate and any overtime premium.
- Calculate deductions. Use current official tables or guidance, or let a professional or provider do it.
- Pay the employee. Provide pay on the agreed date, with a statement showing how it was calculated if the law requires one.
- Pay the authorities. Withheld amounts and employer contributions usually must be sent to government agencies by set deadlines. Missing these can attract penalties.
- File required reports. Many places require periodic or year-end reports.
- Keep records. See below.
Withholding: money that is not yours
Amounts withheld from pay are often held on behalf of the government. Treat them as separate from your operating money. A common mistake is spending these funds and then struggling to pay the authority. Planning around your cash flow, and keeping a clear view of what is owed and when, helps avoid that. Late or missing payments can have serious consequences in many jurisdictions.
Record keeping
Good records protect you and your employees. Typical items to keep include:
- Employee details and signed agreements.
- Rates of pay and any changes.
- Hours worked, leave taken and overtime.
- Each pay run: gross pay, deductions, net pay and dates.
- Proof of payments to authorities.
- Required forms and eligibility documents.
How long you must keep them differs by place, so find out the requirement. Store records securely, since they contain personal information, and keep them separate from casual files; the principles overlap with cyber threats precautions. Good bookkeeping basics and tidy tax records make year-end work easier.
Employee or contractor matters here
Payroll applies to employees. A true independent contractor generally invoices you and handles their own taxes, and the rules differ. Because mistakes in classification can carry consequences, determine the right category before paying anyone.
Do it yourself, or get help?
Small employers commonly choose one of these routes:
- Do it manually, with official tables and calculations. This is workable for a very small team only if you are careful and the rules are simple.
- Use a payroll service or accountant, who handles calculations, payments and filings. This costs money but reduces the risk of errors.
- Use software or a provider, which can automate calculations and reporting. Choose carefully and make sure it fits local rules; you remain responsible for the result.
Weigh the cost against the time and risk. Many owners find that outside help pays for itself in peace of mind, though that depends on your situation. Include the cost in your business budget.
Common mistakes
- Paying cash off the books. This can breach tax and employment laws and leaves no records.
- Missing deadlines for remittances.
- Miscalculating overtime or leave.
- Treating employees as contractors to avoid payroll.
- Failing to keep records.
- Paying late. Late wages can cause hardship and may break the law.
Plan ahead
Before the first hire, get advice on registering as an employer if that is required, setting up a pay process and choosing a pay schedule. Allow for the extra costs described in your plans, and make sure there is money in the bank to cover each pay run. Careful setup at the start saves trouble later, and a professional can confirm that you have not missed anything for your particular situation.