What is Payroll Processing?

Summary: Payroll processing is the important HR function of calculating employees’ salaries and deductions and getting that pay into their pockets.

Payroll processing is the entire procedure of paying employees and contractors their wages and salaries. This is a crucial human resources (HR) function for any business, and it has to be regularly performed on a weekly, bi-weekly, or monthly schedule or following a different pay period.

Payroll staff need to calculate the earnings of each individual employee depending on how much they worked in a pay period. This can include bonus pay and other incentives, allowances, and reimbursements. They then need to figure out how much of their earnings need to be withheld for taxes, social contributions, and possibly wage garnishments. This leads to the total that the employee should be paid, and this amount is what payroll staff issue to them. They repeat this process for every employee and maintain pay records. This is the essential core of payroll processing.

How does payroll processing work?

A company’s payroll is normally processed by its HR personnel, either by HR generalists or dedicated payroll specialists. However, it’s also possible for a company to outsource this processing function to a third-party payroll service provider (PSP).

In either case, payroll processing can be broken down into three distinct stages: pre-payroll activities, active payroll process, and post-payroll activities. Here’s how each of these stages works:

Pre-payroll activities

Pre-payroll activities include everything necessary to set up and manage a payroll process. These actions are normally performed by payroll managers in conjunction with the VP of Finance or even the chief financial officer (CFO) of a company. Here are the most common activities needed to set up a payroll process:

Obtain an EIN: Getting an employer identification number (EIN) is an essential part of business registration. Without one, your business does not legally exist. This is also called a federal tax ID number and identifies your business as a legal entity. The EIN allows your business to pay taxes and withhold taxes from your employees.
Register with the SSA: It’s critical to register your business with the Social Security Administration (SSA) in the US or similar government bodies in other countries so that you can hire employees legally. Registration allows you to deduct contributions from your employees’ salaries and pay your mandatory employer contributions to social security programs.
Choose a pay period: You’ll need to decide how often to pay your employees. You may be able to choose from daily, weekly, bi-weekly, semi-monthly, or monthly periods. However, this period might be pre-set by local laws or enshrined in collective agreements. Longer pay periods benefit employers by allowing them to save the resources needed to process payroll frequently. Shorter periods benefit employees by giving them quicker access to their wages.
Set a payment method: A business will need to choose how it will pay its employees. Since actual cash payments are highly impractical and difficult to trace, companies normally choose to pay by direct deposit into employees’ accounts, by check, or using pay cards. Businesses can also use multiple payment methods.
Set payroll policies: A company’s payroll policies are highly influenced by labor laws, which determine how and how often employees need to be paid. However, it may also need to set its own punitive rules (lateness, absences, etc.) or incentives (bonuses, commissions, etc.), which will help define how much each employee’s gross pay is in each pay period.
Implement a payroll system: You’ll need to choose a system for collecting and recording data and calculating pay. These days, this is done using payroll software. The payroll system will either be implemented in-house by HR staff or by a third-party PSP.
Collect data: You’ll need to collect the personal information from your employees (account numbers, tax IDs, social security numbers, etc.) from your employees so you can pay them. You’ll also need to set up a system for reporting their hours worked so you can pay them accurately.

Active payroll process

Once a payroll system is in place and management decisions are in place, actual payroll processing can be performed regularly. The main activities involved in processing payroll regularly include:

Validating data: A system of checks and balances will allow your payroll staff to cross-check the data they receive about hours worked, overtime, bonuses, benefits, benefits, and deductions. Before they can do their calculations, they need to ensure this data is correct, or staff will be under- or overpaid.
Calculating gross pay: An employee’s gross pay is how much they should receive for the hours they worked during the pay period at their standard rate of pay.
Determining additions: If an employee works overtime, earns a bonus, needs to be compensated for out-of-pocket expenses, or deserves an allowance, these amounts need to be calculated and added to gross pay.
Determining deductions: Employers are normally responsible for withholding tax and social contributions from each employee’s salary. Court-ordered wage garnishments may also need to be withheld, and these amounts are subtracted to produce the net pay amounts that each employee should be paid.
Issuing payments of net pay: Once you’ve calculated net pay, you need to issue these payments to all employees. This entails issuing paychecks in the employee’s name, issuing a pay card, or transferring funds to their bank account.
Issuing payslips: Employers are legally required to issue payslips, also called pay stubs, to their employees for every pay period. These pay slips show each employee their pay breakdown and let them check its accuracy.

Post-Payroll activities

While the active payroll process is the main focus of payroll processing, that’s not all there is to it. Once pay has been issued to employees, there are still several activities that payroll professionals need to do to complete the process.

Paying taxes and social contributions: Employees’ tax and social security deductions will have already been calculated so now it’s time to submit these payments to the appropriate authorities. This includes the contributions that employers must make as well. Payroll staff send these payments and submit reports to the relevant government agencies.
Keeping records: Payroll staff are responsible for keeping all the data for processing payments and producing records of them for future reference. Payroll software usually stores all of these records automatically, but you should also back up this data to make sure it doesn’t get lost or corrupted.
Producing internal reports: The finance department of every company needs to have accurate payroll figures in order to make their calculations and decisions. Payroll staff, therefore, need to produce reports showing payroll totals and breaking down expenses accurately.
Auditing: It’s crucial to occasionally audit payroll to ensure that it’s being performed correctly. Overpaying employees can be a big source of lost revenue for any business. Likewise, underpaying employees or making incorrect tax and social security contributions can lead to fines or even legal action.
Monitoring compliance: New laws and regulations may require you to make changes to your payroll process. It’s important for payroll staff to keep abreast of any new laws that could affect how and how much employees get paid.

Payroll processing checklist

Your business can make a checklist to ensure nothing is missed in this important process. Most payroll processing checklists will include these actions:

Register a tax number.
Register with social security offices.
Create a payroll schedule.
Implement a payroll system, software-based or manual.
Collect employee information (payment information, tax number, social security number, etc.)
Collect employee working data (hours worked, overtime, etc.)
Verify data.
Calculate gross pay, additions, deductions, and net pay.
Submit payments to employees.
Issue pay slips.
Report on and pay taxes.
Report on and pay social security contributions.
Update records.
Produce internal reports as needed.
Audit the payroll process.
Monitor compliance and update the payroll process as needed.

Payroll processing for businesses

Small companies often rely on their HR generalists to handle payroll. As they grow, however, most enterprises will hire dedicated payroll managers or outsource their payroll function to PSP. Whoever is responsible for payroll processing, a system must be in place for collecting data and calculating pay, and reporting must be done afterwards. That’s the only way that payroll processing can be completed.

FAQ

What is payroll software?

While some companies, especially small enterprises, may calculate payroll manually, this is time-consuming, prone to error, and completely impractical for larger businesses. Instead, most companies use computer software to collect and store data and make payroll calculations. Payroll software packages do, however, represent a cost for subscriptions and may require users to attain a level of technical expertise to use them.

What is a payroll service provider?

A payroll service provider (PSP) is a third-party company that specializes in processing payroll for other companies. Their clients outsource payroll processing to them in exchange for a regular fee, and PSPs perform all or most of their payroll functions. However, when using a PSP, the employer is still legally responsible for filing tax returns and paying employees correctly.

Drew Donnelly

Director, Regulatory Affairs

Andrew (Drew) joined the Remote People team in 2020 and is currently Director, Regulatory Affairs. For the past 13 years, he has been a trusted advisor to C-Suite executives and government ministers on international compliance and regulatory issues. Drew holds a law degree from the University of Otago, a PhD from the University of Sydney, and is an enrolled Barrister and Solicitor of the High Court of New Zealand.