Here’s a guide to understand how to do payroll for small business owners.
There is more to managing payroll than just writing checks. Payroll is both a legal and financial responsibility for small businesses because it involves withholding taxes, calculating deductions and funding benefits. The goal is to compensate employees for the hard work they do, but there is more to it. Once you factor in things like health insurance deductions, Social Security and Medicare contributions, it may become a complex process, but, an absolute necessity whether you run a small business or a large corporation.
It may take time to learn the ins and outs of payroll accounting, but it begins with understanding some of the basic concepts and terminologies.
What is Payroll?
Payroll is an accounting of money due to employees of the company for:
- Salary – Salaried employees earn a specific annual amount instead of hourly pay
- Hourly wages– Employees that receive pay based on the number of hours they work
- Bonuses and commissions– Extra pay offered for meeting specific guidelines or milestones
- Overtime – Pay for work in excess of 40 hours per week
It also includes employer-paid benefits such as:
- Sick days
- Insurance – health, dental, vision, life, and disability
- Retirement plans
- Profit-sharing plans
- Part of issuing payroll is withholding taxes and paying incidental costs like:
- Social Security
- Federal income tax
- State income tax
- State unemployment tax
- Federal unemployment tax
- Worker compensation insurance
All these specific functions fall under the category of payroll. It is one of the most critical financial elements of running a small business because errors can have a significant impact on both the employee and employer. Payroll is subjected to scrutiny by federal and state agencies, so it requires precision and detailed documentation.
What are Payroll Withholdings?
Payroll withholding is money taken out of employee’s gross pay. They generally include:
- Federal Insurance Contribution Act (FICA) – The employee contribution to Social Security and Medicare taxes
- Federal income tax – Estimation of what the employee is expected to owe the federal government based on wages and personal information such as exemptions
- State income tax – Estimation of what the employee is expected to owe the state government
- Court-ordered withholdings like garnishments or child support
- Other forms of withholdings such as repayment for payroll advances, union dues or pretax contributions to healthcare savings accounts
Net pay is the amount of money the employee receives after the withholdings.
What are Employer-Paid Costs and Benefits?
There are expenses related to payroll beyond just what a small business pays to the employee. Calculating these additional factors is as essential to managing payroll as issuing employee checks. Additional costs include:
- Employer’s contribution to Social Security and Medicare
- State and federal unemployment tax
- Workers compensation insurance
- Employer’s contribution to insurance programs like health and dental
- Paid time off for vacation, holidays or illness
- Employer contributions to retirement plans like 401(k)
- Employer contributions to pension plans
- Post-retirement health insurance as part of the retirement benefits offered to some employees
What Small Business Can Learn From Payroll
Payroll is an intricate part of a small business’s financial accounting. Evaluation of the overall payroll data allows business owners to do financial forecasting. If payroll is eating into profits, then it’s possible that your business may have too many employees. On the contrary, when earnings are up and payroll is down, adding additional people may help the business grow.
Now that you have a basic understanding on what payroll is, you may still prefer to hire someone else to help you with your employees’ payroll. Other than doing it yourself, some businesses also opt to outsource their payroll functions to payroll service companies.