Understanding Business Basics: Accounting A 5-Part Mini Series

Managing Payroll

For many businesses, payroll is one of the largest expenses and a critical function of their operations. It involves maintaining accurate records of employee wages, taxes, and other deductions, as well as complying with state and federal laws related to payroll, such as withholding taxes for Social Security, Medicare, and income tax. Payroll is a process that involves several steps, including:

  • Tracking employee time and attendance: Employers must track the time that employees work, including regular hours, overtime, and any paid time off. This can be done using time clocks, manual timesheets, or automated timekeeping systems.
  • Calculating employee pay: Once employee time is tracked, employers must calculate the amount of pay that each employee is owed, taking into account factors such as regular and overtime hours worked, any deductions or withholdings, and any bonuses or commissions earned.
  • Withholding taxes and other deductions: Employers are required by law to withhold certain taxes, such as federal and state income tax, Social Security tax, and Medicare tax, from employee paychecks. Other deductions, such as health insurance premiums, retirement contributions, and wage garnishments, may also be withheld.
  • Issuing paychecks or direct deposits: After all calculations and deductions are made, employers can issue paychecks or use electronic direct deposit to distribute employee pay.
  • Record-keeping: Employers must maintain accurate records of employee pay, taxes withheld, and other deductions, as well as comply with state and federal laws related to payroll.

How to Reduce Payroll Cost

Labor costs typically constitute the most significant expense in many industries. Payroll expenses alone can account for as much as 70% of total operating expenses. This is primarily due to additional obligations that employers must fulfill in addition to the direct payroll costs. These obligations include Federal and State unemployment taxes, worker’s compensation insurance, the employer’s share of FICA tax, and employee benefits. To mitigate payroll costs, consider the following strategies:

  • Reduce Employee Turnover: High employee turnover can result in higher SUTA tax rate, increased administrative costs associated with processing terminations, hiring and training new employees, and managing associated paperwork. By lowering turnover rates, businesses can save on these administrative expenses, indirectly reducing overall labor costs, including unemployment taxes.
  • Monitor Payroll to Revenue Ratio: This is an effective way to gauge employee productivity by measuring the efficiency between employee costs and revenue output. While there is no universally defined ideal percentage, it is recommended to compare the ratio with historical company data or benchmark it against other businesses within the same industry.
  • Evaluate Overtime: Monitor and manage overtime hours effectively as this costs 50% more than the regular hourly wage. Implement policies to control excessive overtime and explore alternatives such as hiring additional part-time or temporary employees during peak periods.
  • Performance Management: Implement performance management systems and practices to identify and address performance issues promptly. This helps optimize employee productivity, minimize inefficiencies, and ensure a fair and effective distribution of compensation.
Why it’s important

Payroll is important for several reasons:

  • Accurate record-keeping: Proper payroll management involves maintaining accurate records of employee hours worked, wages earned, and taxes withheld. This information is essential for preparing tax returns, responding to audits, and resolving any disputes related to employee compensation.
  • Financial management: Payroll is typically one of the largest expenses for a business. Proper payroll management can help companies manage their cash flow, budgeting, and forecasting, as well as make informed decisions about hiring and compensation.
  • Compliance with tax and labor laws: Employers are required by law to withhold and pay various taxes, including federal and state income tax, Social Security tax, and Medicare tax, from their employees’ paychecks. Failure to comply with these tax and labor laws can result in costly penalties, fines, and legal consequences.
  • Employee satisfaction: Employees rely on their paychecks to cover their expenses and support their families. Accurate and timely payroll processing helps to ensure that employees are paid on time and in full, which can boost their morale and job satisfaction.