Payroll 101 – A guide for SMEs
Payroll is one of the most time-consuming, stressful, yet ultimately important administrative functions of your business. It involves the timely payment to your employees, and monthly reporting to HMRC. SMEs simply cannot afford to get this wrong.
In this article, we’ll cover the following topics:
- What is payroll? What is PAYE?
- Does your business need to use payroll?
- How does running a payroll work?
- Examples of PAYE deductions for an employee and an employer’s contribution
- Tips for managing a payroll
- Do you need to outsource your payroll function?
What is payroll? What is PAYE?
Simply put, payroll is the process by which employers pay their staff for their work. This includes the process of calculating and logging the gross and net pay of the employee and the contributions to be made to HMRC for their National Insurance and income tax .
In the UK, these figures are estimated by a process called PAYE (standing for pay as you earn) which is administered by HMRC.
Does your business need to use payroll?
Any limited company which has employees is legally required to set up a payroll, and take part in PAYE. This also applies to self-employed people that are established as limited companies, even if they have no employees.
The level of penalty for incorrect payroll reporting can amass to 100% of the taxes, so it’s important to establish a payroll in a timely fashion, and to ensure compliance.
The process of setting up a payroll with HMRC is quite simple however. Here are the steps required as listed on the government’s website:
- Register as an employer with HM Revenue and Customs (HMRC) and get a login for PAYE Online
- Choose payroll software to record employee’s details, calculate pay and deductions, and report to HMRC.
- Collect and keep records.
- Tell HMRC about your employees.
- Record pay, make deductions and report to HMRC on or before the first payday.
- Pay HMRC the tax and National Insurance you owe.
To complete this process you will need each employee’s full name, National Insurance number, date of birth, their tax code, and if they have to make contributions towards a student loan.
If your business works with subcontractors or sole traders exclusively, you may not be required to run a payroll. However, it is important to note IR35 regulations, which have put greater scrutiny on such employment arrangements. If HMRC investigates, and finds that workers that should be considered employees have been paid as subcontractors, then your business could be at risk of receiving a fine. You can read more about IR35 legislation in our explainer article.
How does running payroll work?
For companies following a typical financial year, a tax month runs from the 6th of one month to the 5th of the next. To ensure compliance, your business needs to undertake the following process by the 5th of each month:
- Record all employee pay, whether that is salaried or hourly
- Calculate all deductions from their pay, this will include income tax, National Insurance contributions, voluntary contributions to a workplace pension, student loan repayments, repayments from an employee to their employer e.g. an advance on wages or contribution towards a loan for travel. There are other possible deductions relating to specific industries or scenarios, for a full list, visit the government website.
- Calculate the National Insurance contributions you owe as an employer, this is a flat rate of 13.8% of each employee’s wage
- Produce payslips for each employee, this must include the employee’s earnings before any deductions, the earnings they receive, their hours worked, the amount of any deductions that may change from payslip to payslip e.g. National Insurance or income tax. Employers must also provide a written statement of the reasons for any deductions they have made, either on the payslip itself, or in a separate written statement.
- Report all pay deductions to HMRC, via a full payment submission before the 5th of each month
Once this process is completed, you will be notified of the National Insurance contributions the company is expected to make that month. You should receive notification within two working days.
Payment of employer contributions is expected by the 22nd of the month, however if your company’s contribution is under £1500, you can negotiate a quarterly payment instead.
The penalty for late filing is in the table below:
|Number of employees||Monthly penalty|
For first time filers, there is a 30 day grace period. HMRC also generally allows for submissions to be late by three days, but may begin to pursue repeat offenders.
For more information on how this process works, visit the government website.
Examples of PAYE deductions for employees and an employer’s contribution
Often, employees may have a question regarding the PAYE process, and why a deduction may have been made, or looks slightly different to the previous month.
As we outlined above, a payslip should contain:
- Gross income for the month, the amount they have earned from their salary or their hourly work
- Net income, the amount they receive following all deductions
- Total deductions
- A summary of deductions which vary from month-to-month such as income tax, National Insurance or student loan
- The number of hours worked, if the employee is paid hourly
- Any voluntary contribution towards a workplace pension
With this in mind, let’s take an example of an employee payslip. Employee A is paid £15 per hour, and has worked 160 hours in the previous month. They are paid monthly.
They choose to pay 3% of their salary into a workplace pension, and don’t hold a student loan. They are a category A payer of National Insurance. (To learn more about the different categories of National Insurance, visit the government website)
Employees pay 0% towards National Insurance for the first £1048 they earn per month, 12% on earnings between £1048 and £4189 per month, and an additional 2% for any earnings above that benchmark.
They also pay no income tax on the first £1047.50 earned per month, and 20% on income between £1047.50 and £4190 per month.
As such, the summary of Employee A’s pay and deductions would look as follows:
|National Insurance Contribution||£162.64|
What contributions would the employer have to make in this instance? Employee A’s company would be required to pay a rate of 13.8% (on gross pay above £758 / month) towards their National Insurance, and pay at least 3% into their pension scheme.
|National Insurance Contribution||£331.20|
|Total cost per month||£2,803.20|
Tips for managing a payroll
One of the biggest causes of discord in a business is the improper management of a payroll. If there are mistakes, or if you fail to pay staff promptly, there can be issues with morale, and a lot of work to get the situation sorted. To run an effective payroll function, follow these tips:
- Keep accurate employee records – Ensuring you have all of the relevant information for staff is vital, as this is used to accurately estimate their deductions, and thus their net monthly pay. Previous records can also be used as a benchmark against which you can identify mistakes, or explain changes to staff. You are required to keep payroll documents for three years by law.
- Keep up to date with new legislation – You must keep up to date with changes in legislation, or risk fines from HMRC. There are a number of laws that pertain to payroll, from the National Minimum Wage Act to GDPR.
- Leverage technology & automate the process – Modern accounting software houses a range of features that can help to automate your payroll processes. For example Xero’s payroll software allows you to update your payroll information in just a few clicks.
- Be transparent – When employees feel like payroll is handled behind closed doors, any genuine discrepancies or errors may be seen as intentional. Let your staff know when you run payroll, when they can expect payment, and how the process works.
Do I need to outsource my payroll function?
For SMEs that don’t have an internal HR team, outsourcing your payroll is often the right step. If you as a business owner are having to oversee a monthly function that demands your attention both during and after the process, you should look to entrust it to a professional service.
A 2019 Yougov survey found just 28% of companies use another business to manage their payroll. That’s the most outsourced function in the UK, but I’d argue that could and should be higher.
We wrote an article explaining the process of outsourcing your payroll, and we listed a number of the benefits. To get all the details, head over and read the article in full. Here’s how we’d summarise the pros:
- Reduce costs
- Save time
- Ensure compliance
- Reduce mistakes
- Gain access to expertise
At Pennyhills, we’re on top of the latest legislation, automation and innovation in the payroll industry. To find out more about how we can run this crucial function of your business with transparency, sensitivity and efficiency, drop us a line today.
Payroll is just one aspect of Pennyhills outsourced accounting service. To find out more about our approach, read our guide to outsourcing your accounting today.