Payroll is one area of your business that can be either complicated or straightforward, depending on how you approach it.
It requires you to closely manage your cash flow, meet strict tax obligations, and remain reliable to all of your employees. At the same time, there are a number of structures and tools that are designed to simplify the process and make payroll easy to manage.
Continue reading this article to learn more about payroll best practices that small business owners need to know to keep your operations running as smoothly as possible.
Why Payroll Matters for Small Businesses
Labor is one of the largest expenses for most small businesses, running anywhere from 20 to 35% of your gross sales. Outside of your budget, payroll also has a direct impact on your ability to retain strong employees.
When you handle payroll correctly, your finances stay in order, and your employees know they can rely on you. But when issues arise, you can end up facing costly fines or losing trusted employees. Effectively managing payroll helps you avoid issues and build a healthier business that’s ready to scale.
Payroll Basics Every Small Business Should Understand
Even if you outsource payroll, it’s important to be informed about the basics. You don’t need to memorize all of the U.S. employment tax codes, but you need to know enough payroll basics for small business operators to make informed decisions and ensure everything is being handled correctly.
Properly Classify Employees vs. Contractors
There’s no magic formula to help determine whether someone is an employee or an independent contractor. In general, the more control you have over how, when, and where someone works, the more likely they are to be classified as an employee. If they operate independently, set their own schedule, and use their own tools, they’re more likely to be a contractor.
When you pay employees, the IRS requires you to withhold and deposit certain taxes. If a worker is misclassified as a contractor, and these taxes aren’t paid in a timely manner, you could be responsible for back taxes, penalties, and other expenses.
Understand Payroll Taxes and Withholdings
Payroll taxes aren’t optional, and they can get complicated. As an employer, you’re responsible for calculating, withholding, and submitting several types of taxes, including federal income tax, Social Security, and Medicare taxes. Depending on your location, you may also need to handle state and local income taxes or unemployment taxes.
In addition, you’re not just withholding taxes from employee pay—you also have to match certain contributions and pay taxes on the employer side of things. All relevant tax information is available online, but it often helps to work with a tax professional who can help you cover all your bases.
Choose the Right Pay Schedule
According to the U.S. Bureau of Labor Statistics, a biweekly pay schedule is most common (39%) for small businesses, but it’s far from your only choice. Almost a quarter of small businesses (24.1%) pay their employees every week, followed by semimonthly (22.5%) and monthly (14.5%).
Pay frequency also varies widely by industry. For example, 65.4% of construction companies pay their workers every week, compared to just 9.9% of businesses in education and health services.
Employees often prefer weekly and biweekly pay schedules because they provide more frequent pay, but they require more admin work and tighter cash flow management.
Monthly schedules reduce processing time, but they’re harder for employees who rely on consistent cash flow. Look at industry standards and your cash flow patterns to help you determine which approach is best for you.
9 Small Business Payroll Tips and Best Practices
Once you understand how payroll works for small business owners, you’re ready to start building systems that make payroll easier to manage over time. Here are nine small business payroll best practices to make payroll a smoother experience for you and your employees.
1. Automate Payroll to Reduce Errors
Running payroll by hand may save you a little bit of money up front, but it poses a much higher risk of calculation or typing errors. It’s ridiculously easy to transpose a 4 and 7 or add an extra 0 to a number, and one simple mistake can result in hundreds of dollars of miscalculated payroll. Automation helps you avoid manual errors and save time during each payroll period.
2. Set Reminders for Tax Deadlines and Filings
Tax deadlines are easy to miss. The IRS isn’t sending out reminders, and you’re busy juggling a hundred other tasks on your to-do list.
Set recurring reminders for key deadlines like:
- Quarterly Form 941 filings
- W-2 distribution (due January 31)
- New hire reporting requirements within 20 days of hiring
3. Invest in Effective Payroll Software
Most modern payroll software options do more than calculate wages. They also withhold taxes, generate pay stubs, and file payroll taxes on your behalf. Using software also reduces payroll compliance mistakes because the tools stay up-to-date on every regulation change. Look for built-in payroll management best practices like direct deposit, employee self-service portals, and reporting tools.
4. Separate All Payroll and Business Finances
Mixing payroll funds with your general operating money can get confusing. Keeping payroll funds separate has several benefits:
- It reduces the number of transactions in your main account.
- Auditing payroll becomes more straightforward.
- If employees are hacked or forge transactions, the majority of your funds are safe in a separate account.
- Keeping withheld money in a separate account reduces the risk of accidentally spending it.
5. Maintain Clear Communication With Employees
With every new hire, be up front about pay schedules, how hours are tracked, overtime policies, and when employees can expect their paychecks. Put it all down in writing for them to refer back to. Anytime something changes, like a holiday schedule or delay, let your employees know as soon as you can—57% of Americans are living paycheck to paycheck.
6. Regularly Review Employee Classification
Employee classification isn’t a “set it and forget it” concept. As your business evolves and your team changes, roles can shift as well. A worker who started out as an independent contractor might now meet the criteria of an employee, and then it’s up to you to adjust payroll accordingly.
7. Back Up Payroll Data Securely
Payroll data includes sensitive information like Social Security numbers, bank details, and wage history. All physical and digital copies of your data should be locked up tight. If you use a payroll system, choose one that automatically backs up data to a secure, encrypted location, and only provide access to people who truly need it.
8. Conduct Routine Payroll Audits
Even if you have a solid system in place, small business payroll errors can slip through over time. Running regular audits helps you catch those issues before they snowball into bigger, often expensive problems.
A routine audit should:
- Review employee classifications
- Verify pay rates
- Double-check compensation, such as overtime pay, tips, shift differentials, etc.
- Check tax withholdings
- Ensure hours are recorded accurately
An in-house audit is also a good way to make sure all of your paperwork and documentation is sound, in case you’re ever audited by the IRS or Department of Labor. Aim for consistent quarterly reviews to keep things on track.
9. Consider Payroll Funding
If your business deals with uneven cash flow, like seasonal fluctuations or longer invoice terms, payroll funding can help bridge the gap. This type of financing, also known as invoice factoring, allows you to access the cash tied up in your unpaid invoices so you can meet payroll on time. Payroll funding is especially useful for companies that are less established, growing rapidly, or working in a staffing-intensive industry.
In-Summary: Small Business Payroll Tips & Best Practices
Payroll doesn’t have to be overly complicated or time-consuming, but it does require you to have the right systems in place. When you understand small business payroll basics, automate whenever possible, and seek professional help when needed. If you do this, payroll can be a predictable, low-stress part of your business.
Think Payroll Funding Is a Fit for Your Business?
Payroll funding is a powerful tool, but it’s not the right solution for every business.
Business owners who benefit most from payroll funding tend to find themselves in a period of rapid growth, operating a staff-heavy business model, or working on long payment cycles.
If any these apply, it may be worth looking into payroll funding. Feel free to fill out our quote form to get matched with a payroll funding company that suits your business.