Many of us take being paid the right amount on payday for granted, but a great deal of work goes on behind the scenes to make this happen.
An efficient payroll process is vital for businesses of all sizes to ensure their employees are paid correctly and on time. It’s also essential for businesses to demonstrate to the taxman that they are following the rules and operating correctly.
This in-depth guide will tell you everything you need to know about payroll, including how it works, how to set it up, who manages it, and why it’s so important to get it right.
Table of Contents
- What Does Payroll Mean?
- Why is Payroll Management Important For a Company?
- How Does Payroll Work?
- Who Manages Payroll?
- How To Set Up Payroll?
- How Are Payroll Deductions Calculated?
- What is a Payroll Number & Where is it on a Payslip?
- What is Payroll Tax & How is it Calculated?
What Does Payroll Mean?
You’ve probably come across the term before, but what does payroll actually mean? The term ‘payroll’ refers to the entire process that deals with an employee’s wage and tax.
In its simplest form, businesses use payroll systems to pay their employees. Payroll is designed to pay the right amount of money to the right people on the required dates.
Payroll also ensures that the right amount of tax is paid to HM Revenue and Customs (HMRC) through the Pay As You Earn (PAYE) system, as well as ensuring any other deductions, like pension contributions and student loan repayments, are correct.
Why is Payroll Management Important For a Company?
Getting the payroll process right is vital for all businesses of all sizes. Payroll is essential for making sure employees are paid correctly and on time.
Payroll also allows companies to fulfill their tax obligations to HMRC. Failure to do this can result in steep fines and penalties. Payroll is often the highest expense for a business, so it’s only natural for businesses to want to get it right.
How Does Payroll Work?
Employers are required by law to work out how much tax their employees owe, deduct it from their salaries, and send it to HMRC. The payroll process is broken down into four key tasks:
1. Recording Pay
The payroll process starts by recording the total pay an individual employee should receive. This includes their salary and any other pay. Any added pay could be statutory sick pay, statutory pay for parents (for example, maternity pay), bonuses, commission, or expenses. For many employers, paying expenses through payroll is the easiest option.
2. Calculating Deductions
The next stage is to calculate deductions that need to be taken from an employee’s salary. The most common deductions are Income Tax and National Insurance contributions, which is done through HMRC’s PAYE system.
An employer may need to make additional deductions to an employee’s pay for student loan repayments, pension contributions or child maintenance payments.
3. Producing Payslips
Businesses must provide employees with a payslip on or before their payday. This shows employees how much has been taken from their pay in deductions and how much they will actually receive.
4. Reporting to HMRC
Employers must then report their employees’ pay and deductions to HMRC in a Full Payment Submission (FPS). This is an employer’s proof that their payroll is working correctly and they’re paying the right amount in tax.
Who Manages Payroll?
In smaller businesses, payroll can be managed by one or two people. Most businesses opt to use payroll software, which makes the whole process easier to manage.
The payroll function often sits with a specific department, which could be Human Resources, Finance, or a dedicated Payroll department, depending on the size of the organisation.
Some companies outsource their payroll function to an accountant, bookkeeper, or specialist payroll provider.
How To Set Up Payroll?
If you’re looking to set up and run payroll for your business, there are two options to choose from;
1. Do It Yourself
You can set up and run payroll yourself, but it’s important to get it right to ensure your employees are paid the right amount on time.
You will need to use payroll software to report to HMRC. HMRC can’t make recommendations on what software you use, and different software offers different services, so you’ll have to make sure the software you choose is right for you.
2. Pay a Payroll Provider
Many companies choose to pay a payroll provider, like an accountant or bookkeeper, to set up and run payroll on their behalf. This takes some of the pressure off the employer, but they are still legally obliged to ensure PAYE tasks are completed, even if the process is outsourced.
Employers can’t be completely hands-off – they still need to give the payroll provider accurate records and data in order for them to run payroll.
How Are Payroll Deductions Calculated?
As part of the payroll process, employers need to work out how much employees need to pay in income tax and National Insurance, so this can be taken directly from their salary.
This is calculated using an individual employee’s tax code and National Insurance category letter, which can be found on a payslip.
Employers may be required to make additional deductions to an employee’s pay for:
Pension contributions
Student and Postgraduate loan repayments
Payroll Giving donations
Child maintenance payments
What is a Payroll Number & Where is it on a Payslip?
A payroll number is a series of numbers and letters that is unique to individual employees. An employer will often assign employees a payroll number to distinguish between each employee.
Companies with larger workforces are more likely to issue payroll numbers as it makes it easier to secure employees’ important personal data, as it can be linked to their payroll number.
A payroll number is usually included on an employee’s payslip towards the top, often next to the employee’s name and pay date.
What is Payroll Tax & How is it Calculated?
A payroll tax is defined as a tax that employees and employers pay on wages, tips, and salaries. It’s usually calculated as a percentage of the salaries that employers pay their employees.
In the UK, Income Tax and National Insurance contributions are clear examples of payroll taxes, as these are deducted directly from an employee’s salary.
As you can see, a great deal of work goes on behind the scenes to make sure every employee gets paid the right amount on time and the company stays HMRC compliant.
