Understanding Payroll Costs for Small Businesses
6 min. Read
Last Updated: 01/25/2024
Table of Contents
Payroll costs for small businesses go well beyond the wages paid to employees. Accurately determining the total costs of paying employees is essential to understanding your business's financial health and pinpointing areas where you can streamline.
What Are Payroll Costs?
Payroll costs are the total expenses associated with compensating employees for their work at your business. What are typical payroll costs?
- Base pay (whether paid on an hourly, piece, salary, or other basis)
- Bonuses and commissions
- Paid time off and other employee leave
- Employer's portion of payroll taxes
- Employee benefits contributions
- Workers' compensation insurance
- Payroll administration costs
You may also have additional fees if you use payroll or accounting software, such as payroll processing fees, payroll tax filing costs, or other add-on services. While certainly an extra expense, many businesses find that investing in a third-party payroll solution pays off in the long run since this option can help mitigate payroll errors, provide additional tools to help them follow applicable laws and regulations, and save time each pay period.
How Much Does Payroll Cost for Small Business?
There are many options to run payroll, all of which come with associated costs of payroll services for small businesses. Here's a breakdown of some of the costs involved in the more common payroll methods, financially and otherwise.
A business owner has every right to keep payroll in-house, in which case they, or dedicated members of their staff, have total control over the process. Overall costs could remain relatively low and may encompass the systems and supplies needed to gather employee hours and make payroll calculations, printing paychecks, and direct deposit fees.
However, with this in-house approach also comes learning the basics of properly running payroll every pay period and staying on top of laws related to payroll to avoid making costly mistakes. As the business grows, the payroll process will become increasingly complex. This method can also make the business more vulnerable to mistakes and miscalculations due to the increased risk of human error.
While you can certainly figure out the process, running payroll can be difficult and time-consuming when you do it on your own. Even hiring a dedicated employee to handle payroll means paying that person (including benefits), providing training, and so on. Hiring a CPA for tax planning services will also come with ongoing costs for small businesses.
Using payroll software can help streamline the process and time required to manage payroll. Payroll software for small business costs includes the price of the software itself and possibly installation costs, depending on the platform you choose. The features you opt into and the size of your workforce may also factor into the cost of payroll software.
Most accounting software offers basic payroll functions. Others have more advanced features such as tax filing services. Consider a payroll system that can export all payroll transactions into your accounting system. This will help to ensure that your books and payroll ledgers match up. This can be a critical part of keeping accurate tax records for payroll and business taxes.
Automated Payroll Software
Automated payroll software is an excellent choice for business owners looking to recoup time and resources. This software will generally record and calculate employee paychecks, handle tax payments and deductions, and automate other payroll-related tasks. For an additional fee, many providers will also offer employee self-service options, HR services, and time-tracking capabilities that integrate with the business's payroll system. Note that with any payroll solution, businesses are still responsible for ensuring the accuracy and compliance of their payroll.
The total cost will depend on the features and additional modules chosen, the number of employees, business location, and other factors. Consider Paychex, which has payroll packages starting at $39 per month plus $5 per employee.
Online Payroll Providers
Depending on your business's needs, an online payroll service provider can help you save time and minimize payroll mistakes. It can also be cost-effective over the long term, especially when it can scale to meet your needs as the business grows. This option can help automate administrative tasks such as:
- Payroll processing
- Payroll-related reports
- Tax filing
- New-hire reporting
- Withholding taxes and deductions
- Preparing checks and direct deposits
- Filing federal, state, and local taxes
- Automating deductions for 401(k) contributions or insurance premiums
Depending on the payroll outsourcing services agreement, this payroll option may have a few different fees. Some of these fees depend on how many people the business employs and the frequency of payroll periods. Other fees might be for extra services like setting up employee benefits or providing reports. Generally, businesses can expect to spend between $30 and $100 per person each month in terms of outsourcing payroll services price. Look for upfront, transparent pricing when comparing providers.
Factors Influencing Payroll Costs
Payroll costs can vary significantly depending on the business size, industry, and where you operate. Some of the main factors that impact payroll costs include:
- Payroll frequency: The pay period a business decides makes the most sense can have a direct impact on their payroll costs. Looking at payroll services pricing, some providers will charge for each payroll run, while others offer an unlimited number of monthly payroll runs. This means that the more frequently you pay your employees, the more it could cost. Also consider this factor if you have different pay schedules for different kinds of employees, such as one type of pay period for salaried employees and another for hourly workers.
- Industry: Costs such as workers' compensation and state unemployment insurance vary widely depending on your industry. For example, a company in the construction business will likely have a higher workers' compensation cost per employee per hour versus a real estate business.
- Number of employees on payroll: Payroll processing services typically charge a per-employee fee per month and recurring costs for the service itself. Businesses can expect to spend between $30 and $100 per employee per month with a payroll service provider.
- Direct deposit: There may be a cost associated with the banking software you use to process your payroll transactions. However, using a third-party payroll service provider can often minimize or eliminate this cost, as these providers typically have the necessary processing software already built into their service. There may also be some minimum account balance or per-transaction fees incurred. However, these costs tend to be minor.
- Operating in multiple states: Your payroll can become incredibly complex if you have employees working across the country. That's because no two states are alike regarding payroll tax laws, rules, and regulations. Such complications can quickly lead to avoidable errors, costly mistakes, and wasted time if you handle the process independently. Instead, many small businesses use a third-party service to help them process payroll for employees in multiple states.
Calculating and Estimating Payroll Costs for Small Business
The factors above (and many other variables) all contribute to a wide range of total employee payroll costs. As a general guideline, you can estimate payroll costs by adding up the following:
- Each employee's gross annual pay before taxes are withheld
- The total annual payroll taxes you pay on the employee's behalf
- Any additional expenses you pay on the employee's behalf, such as supplemental and statutory benefits and insurance coverage
A general rule of thumb is that you can expect payroll costs to be about 1.25 to 1.4 times an employee's base pay once you add up the above expenses. So, if an employee is paid $30 per hour, the total payroll cost would be between $37.50 and $42 per hour. You would also have to account for expenses such as recruiting and onboarding costs, ongoing overhead costs, training, equipment, and uniforms the business provides.
Strategies for Managing Payroll Costs
There are concrete steps you can take to help manage day-to-day payroll costs. Beyond that, you may also be able to reduce payroll costs over the long term in the following ways:
- Outsource payroll functions: Consider outsourcing payroll to an expert payroll service provider that can help streamline processes and mitigate payroll errors. You may be surprised after getting a payroll quote that this can be a viable option versus having additional overhead.
- Classify workers correctly: Non-compliance with rules related to worker classification can lead to stiff financial penalties for an employer. If you misclassify an employee as an independent contractor, for example, you may be responsible for paying back payroll taxes for that worker, back pay, and overtime.
- Invest in time tracking: It's worth evaluating your method for tracking employee time. An integrated time and attendance system can sharply decrease expenses related to the collection, management, and data entry involved in a manual system.
- Audit benefits: Even if you offer a robust employee benefits package, this could drain company expenses if some benefits are underutilized. Audit your offerings to ensure they align with your budget and employee preferences.
- Follow applicable business laws: Part of protecting your business's bottom line requires identifying potential areas of non-compliance and solving those vulnerabilities to help minimize their risk to the business. This includes staying on top of ever-changing laws, rules, and guidelines related to payroll and taxes, health and safety, employee rights, and human resources.
Future Trends in Payroll
Payroll has expanded beyond simply issuing paychecks to employees. It has become a dynamic tool for companies to accommodate various and increasing compensation agreements, support contract-based work, and meet employees' requests for faster access to funds and pay-related information. Some growing trends that could impact payroll costs in the future include:
- Immediate access to earned wages: Instant or on-demand pay allows eligible employees to access income as they earn it (typically up to a certain dollar amount each pay period) for a flat, per-transaction fee rather than waiting until the business's next payroll cycle. For employers, pay-on-demand requires time and resources during implementation and ongoing administration. It can also quickly become complex, particularly if you're processing payroll alone. Consider how the business could handle calculating one-off tax withholdings, processing pay quickly, handling garnishment payments if the employee has already withdrawn their wages, and other factors.
- Increased pay: Many workers are unwavering in their quest for fair compensation. For employers, meeting increased pay demands, higher business operations costs, and the possibility of lower profits can make their businesses more vulnerable. Employers must keep a careful watch on their financial metrics and have a plan to help avoid challenges in meeting payroll obligations. Some payroll providers may provide payroll protection that extends the collection of payroll funds from your bank account.
- Timely gig worker pay: While traditional employees are typically paid weekly or bi-weekly, freelance or gig workers may have to wait weeks or months before receiving compensation. Employers who delay paying freelance or gig workers risk losing these skilled and talented individuals to competitors. Outsourcing payroll or using the most current payroll technology can help you take care of your contract-based, freelance, and gig workers with the prompt payments they depend upon and deserve.
- Emerging solutions for more accurate payroll: Rather than processing checks and finding errors after the fact, which take time to correct, building in more front-end reviews can help ensure that payroll is accurate before it goes out the door. Allowing employees to review their pay information before processing payroll is an emerging trend gaining traction. Paychex Pre-CheckSM allows employees to be involved in the payroll process and review their earnings and withholdings for accuracy before payday. Regular access to this information can also help them make necessary adjustments in withholdings or contributions to pre-tax accounts to take full advantage of their benefits package.
Learn More About Small Business Payroll With Paychex
Managing payroll costs for small businesses requires understanding the total cost of paying employees and the time and resources it takes to run and administer payroll, track time, maintain compliance, and many other associated tasks. Consider the small business payroll options available to you and how an initial investment in a payroll solution can make the most financial sense over the long term.