A Guide to Payroll Preparation for Small Businesses

For every small business owner, payroll preparation is an essential part of running your business. It’s a necessary task that ensures your team’s hard work gets rewarded, but knowing how to do payroll involves more than just cutting checks. 

You need to ensure compliance with local and federal laws, take into account overtime hours and vacation, and make sure the right amount goes out to the right person at the right time. Sound overwhelming? Don’t worry, we're here to break it down for you.

What is payroll preparation?

Payroll preparation is the process of calculating and processing employee compensation. It comprises everything from calculating total pay, to deducting and withholding necessary amounts for taxes and other services, to actually paying employees. Regardless of what system you use, the goal of payroll preparation is for employees to be paid accurately and promptly at the end of the day.

Types of payroll systems.

Choosing the right payroll system can make a world of difference in managing your business efficiently. Understanding the options can help you decide what's best for your specific needs.

Manual payroll.

Manual payroll calculations involve doing all payroll math by hand. This method uses spreadsheets or paper-based systems to track employee hours, calculate wages, and determine deductions. You will need to manually enter data, perform calculations, and ensure accuracy.

While this approach can work for very small businesses with a limited number of employees, it is time-consuming and prone to human error. Keeping up with tax rates and regulations also requires constant attention, making manual payroll a labor-intensive option.

In-house payroll software.

In-house payroll software automates many of the tasks involved in payroll preparation. This type of software helps you calculate wages, withhold taxes, and generate paychecks or direct deposits.

It can also handle benefits administration and track employee hours. Using the best payroll software for small businesses reduces the risk of errors and saves time compared to manual methods.

Many payroll software solutions like Homebase offer features like automated tax updates, compliance checks, and integration with other business systems such as accounting and HR software. This makes it easier to manage payroll efficiently and stay compliant with regulations.

Outsourced payroll services.

Outsourced payroll services involve hiring a third-party provider to manage your payroll processing. These providers handle everything from calculating wages and withholding taxes to issuing paychecks and filing payroll taxes.

Outsourcing payroll can save you time and reduce the risk of errors, as these providers are experts in the preparation of payroll and compliance. They stay up-to-date with tax laws and regulations, ensuring that your payroll processes remain compliant.

This option is particularly beneficial for businesses that lack the resources or expertise to manage payroll in-house. Outsourcing allows you to focus on core business activities while leaving complexities like payroll tax preparation to the experts. Your primary job becomes deciding on the best payroll service provider for your small business. 

How to prepare payroll in 7 steps.

So what are the steps in preparing a payroll? Use this guide to ensure that employees are paid accurately and on time. 

Step 1: Choose your payroll system. 

Decide between the three options: manual payroll, using in-house payroll software, or outsourcing payroll entirely. Consider your business size, budget, and specific payroll needs to determine how much you can allocate for payroll management and what features are non-negotiable for your business.

If you’re moving beyond manual payroll, evaluate the features, ease of use, and customer support offered by different payroll solutions. Look for systems that provide comprehensive payroll functionalities, including tax calculations, direct deposits, and compliance management. 

As a bonus, check if your payroll system can integrate timesheets and scheduling like Homebase, so that everything you need to run payroll is in one convenient place. 

Step 2: Create a payroll policy. 

Your payroll policy should first and foremost align with all local, state, and federal labor laws. Make sure to establish a consistent payroll schedule. Whether you follow a biweekly, monthly, or even weekly payroll schedule, make sure your employees know their pay periods and pay dates. Then you should clearly explain overtime and vacation pay, and ensure it follows legal obligations.

Additionally, clarify any relevant withholdings and deductions, as well as any benefits that may impact paychecks. Finally, ensure payment methods are clear for employees—whether through paychecks, direct deposits, or other options. 

Step 3: Gather and verify employee data.

This includes collecting information such as pay rates, tax withholding forms like W-9 forms, and benefits enrollment details. You’ll want to make sure you have all relevant personal information, like Social Security numbers and tax filing status, as well as info like retirement savings plans and health insurance enrollment. 

Don’t forget to collect banking information if you’re using direct deposit! Accurate data is crucial for calculating the correct pay for each employee.

Step 4: Review time sheets and calculate gross pay.

For hourly teams, make sure that your timesheet system is working to accurately track hours worked in alignment with scheduling. You’ll also need to make sure sick time or vacation time is accurately recorded, along with PTO and overtime hours worked. All of these things will affect the final number on an employee’s paycheck. 

Calculate the gross pay for each employee. Gross pay includes the total earnings before any deductions, such as salary, hourly wages, commissions, and bonuses. Make sure to include overtime, bonuses, and other wages. This step ensures that you have the correct base amount from which to make deductions.

Step 5: Withhold necessary taxes and deductions.

Withhold necessary taxes and deductions including federal, state, and local taxes, as well as any employee-authorized deductions like retirement contributions or health insurance premiums. Proper withholding is important to comply with tax laws and ensure employees receive the correct net pay. You can use the IRS Withholding Estimator to help determine how much to withhold from employees for federal requirements.

Step 6: Pay employees. 

Using whichever method you established in your payroll policy, finish your deductions and pay your employees their net pay for that pay period. Make sure all reasoning is clear and easily laid out in a pay stub or other documentation in case employees have questions. 

Step 7: Maintain clear payroll records. 

Throughout this process, maintain accurate payroll records for tax purposes and future reference. This helps in resolving any discrepancies and ensures compliance with legal requirements. Make sure you keep all relevant documents, including time cards, spreadsheets, and copies of checks or deposits for at least 4 years.

If you’ve started a new small business, check out our payroll guide for more detailed information on how to prepare payroll for employees. 

Tips to improve payroll preparation.

As your business grows, payroll will grow more complex. But you and your team can grow to meet the challenges by following these steps: 

• Manage overtime and leave policies. Define what constitutes overtime and how it will be compensated to ensure consistency and fairness. Outline the process for requesting and approving time off, then track leave balances to ensure employees receive the correct amount of paid or unpaid leave.
• Stay informed of current tax laws and regulations. Tax laws and regulations change frequently, and staying compliant requires regular updates to your payroll processes. Set aside time each quarter to review the latest tax laws and guidelines and track changes to your payroll calculations accordingly. 
• Handle payroll errors and corrections. While ideally to be avoided, mistakes are inevitable. Implement a process for identifying and reporting payroll mistakes, and act quickly to investigate and correct any. Maintain a log of errors and resolutions to identify patterns and prevent future mistakes.
• Keep detailed and secure records. Maintain organized and confidential payroll files, including records of hours worked, gross pay, taxes withheld, and net pay. Secure storage protects sensitive employee information and complies with data protection regulations.
• Automate payroll processes. Use payroll software or services to handle calculations and processes. Automation reduces the risk of manual errors and saves time. Besides calculating wages, withholding taxes, and generating paychecks, payroll software like Homebase can even help provide HR and compliance support. 

Prepare your payroll properly.

Payroll is one of those necessary parts of running a business that costs valuable time and money. But to keep your team happy and your business thriving, you need to find a payroll process that works for you. 

Luckily, Homebase has payroll built into our app, which is specially designed for hourly teams. Timesheets that directly reflect your schedule can feed right into the payroll system, which automatically calculates taxes, time off, and more. That way, you can grow your team, not your paperwork. Get started now at Homebase.