If you own an enterprise that employs personnel you will clearly have to pay your workers.
In a larger organization, this will be taken care of by the accounts and HR departments. But what about if you are a small company, maybe even a one-man-band looking to take on your first employee.
The issue of payroll, benefits, holiday pay, and of course taxes will seem very daunting at first. While there are a number of software packages and services available to help manage payroll (see our review of Gusto here), having an understanding of what it all means will be beneficial.
To that end, here’s a little introduction on what’s involved when managing payroll and a simple formula on determining what should be paid.
An employer is expected to pay an employee for the labor provided. This “salary” is specified in the employment contract, which the employee signed when being employed.
For any business, salary is considered the cost of acquisition and retention of human resources that are needed to run business operations, and can thus be described as a salary expense, and this expense is recorded on the payroll account by the accountant.
Apart from salary, the employer can also decide to pay the employee a bonus – which is a form of work benefit – for exceptional work done, but if the work is incomplete, or of inferior/poor quality, then the employer can decide to penalize the employee by deducting some amount from his/her salary.
There are other deductions that the employer may need to make, such as deductions to repay a loan the employee took.
The financial record that contains the salary, bonus, work benefits, and deductions that the employee is entitled to is called the payroll.
The importance of keeping correct records
For the treasury management of a company or firm, the payroll is the financial records of salaries, bonuses, and deductions that employees of the company/firm are entitled to be paid. In the United States of America (USA), this payroll includes the withheld taxes of the employees.
The withheld tax, also called the retention tax, is the income tax deducted from the payroll of an employee by the employer, and it is paid to the tax authorities or governments.
Basically, this withholding tax is the income tax that the employer must pay to the government. The payroll can be handled in-house, or outsourced to an entity that provides payroll processing services.
In-house payroll management
If the company handles it in-house, then the company does all the payroll processing, including maintaining timesheets, calculating the monthly pay, producing appropriate paychecks, depositing the checks to the bank accounts of employees, and remitting withheld taxes to the tax authorities.
The monthly payment is usually calculated using this simple formula in the US:
Monthly Pay = Gross Salary + Total Bonuses – Total Deductions – Total Taxes
The timesheet is used to record how many working hours each employee has clocked in the month. This allows for a more precise calculation of the monthly payment.
This payment can be made through a funds transfer system. This means that cash payments are moved from the bank account maintained by the company/firm – to settle salary expenses – and deposited into the individual salary accounts of employees.
In the USA, this is normally achieved through an electronic funds transfer (EFT) system called the Automated Clearing House (ACH) which is operated by the National Automated Clearing House Association.
The ACH payment allows for direct deposit of the monthly payments to the account of the employee.
This is done as follows; money is removed from the business bank account as an ACH withdrawal, and then deposited into the salary bank account of the worker as an ACH deposit, and this form of funds transfer is called a direct deposit.
Most in-house payrolls are processed at regular intervals according to one of the following 4 most common frequencies: weekly, biweekly, semi-monthly, and monthly. Other less common frequencies are daily, bi-monthly, quarterly, and semi-annually, as well as annually.
The aforementioned processes associated with creating and maintaining a payroll, including frequency of payroll processing, can be outsourced to a payroll processing company (PPC). One of the best payroll processing companies is Gusto.
If the payroll processing company provides the full spectrum of payroll processing services so that the company/business/firm does not need to handle payroll processing, then the PPC is called a full-service PPC.