What is payroll processing? How to process payroll

As an HR or payroll manager, you have the critical responsibility of ensuring everyone is paid correctly and on time. Even one mistake can put employees’ trust and the organisation’s reputation at risk.

Payroll processing, therefore, is a key task and one that need to be done in the right way.

Research by Marlin PR on behalf of Sage shows that 35% of UK workers would find another job if their employer paid them incorrectly even once.

Furthermore, 51% would lose trust in their employer and resent them.

Read this article for a list of key tasks that you have to cover as an HR or payroll manager. And learn more about payroll processing too.

Here’s what we cover:

What is payroll processing?

Payroll processing is the administration of employee pay based on employee type, status, salary, wages, and deductions.

It also involves filing reports and paying employment taxes to HMRC.

These calculations must be made in enough time to follow the organisation’s pay schedule, and in compliance with applicable regulations.

Payroll processing can be complex to manage because of its many varying factors, such as:

• Pay scales
• Employee classifications
• Promotions
• Employee turnover
• Terminations.

It’s essential to have checkpoints in place at the critical points of payroll processing for as much error prevention as possible.

Key elements of payroll processing

Here are ten things that HR managers must do to ensure these calculations are accurate.

1. Start with clean data

Common mistakes such as employee misclassifications (such as typos, spelling errors or incorrect information) happen during onboarding, which impacts your employees’ health insurance and retirement benefits, and tax withholdings.

Add a checkpoint here to confirm the employee classification is correct and for your employee to verify their personal information and tax code are accurate before their first payroll run.

2. Verify timesheet information

For your timesheets, you should have a system in place that checks for inconsistencies with employee type, hours worked, and pay scale.

A preventative measure here reduces the risk of overspend on payroll.

3. Know your total payroll costs

You need to know how much each employee will cost the business beyond their wages to spot inconsistencies during each pay period.

Always factor in gross pay, benefits, tax and National Insurance withholdings for each employee.

You also need to consider Statutory Sick Pay (SSP), statutory pay for parents (maternal/paternal leave), tips, bonuses, pensions, and suspensions as they apply.

Using a payroll budget will help you to track and stay on top of costs related to your people processes.

4. Produce and distribute payslips

You must give each employee and worker a payslip detailing their:

• Gross pay
• Deductions
• Net pay
• Hours worked for that pay period.

Payslips can also include your employee’s National Insurance number and tax code, their pay rate, and their pay and deductions year-to-date.

You may be able to produce payslips using your payroll software if it has this feature. You can use different software if it does not.

You can either print payslips or send them electronically.

5. Make payments and file reports on time

Every month, you have to pay HMRC the tax and National Insurance you owe as reported on your Full Payment Submission (FPS) in the previous tax month minus the reductions on any Employer Payment Summary (EPS) you sent before the 19th in the current tax month.

HMRC will send you a late filing notice if you’ve paid any employees and do not send an FPS or send one late. It can also charge you a penalty unless you have a valid reason for reporting late.

Late, missing or incorrect payroll reports can affect your employees’ Universal Credit payments and tax status.

You should keep a schedule of essential payroll dates, including bank holidays, that impact closings.

6. Complete annual reports and tasks to prepare for the next tax year

You need to report to HMRC on the previous tax year and prepare for the new tax year.

This must include your employees’ pay, payroll benefits and deductions in an FPS.

To prepare for the next tax year, you’ll need to manage the payroll year end process:

• Update employee payroll records from the last day of the tax year
• Give your employees a P60
• Report employee expenses and benefits.

7. Keep excellent records

HMRC can check your files at any time.

By keeping excellent records, you’ll be able to respond quickly if either HMRC or one of your employees has any queries regarding payroll data.

Your policies need to be clear and documented so anyone can follow them.

8. Keep up with the minimum wage

The National Living Wage and National Minimum Wage rates are legally binding and change each tax year.

The National Living Wage is the hourly rate to which all employees aged over 21 are legally entitled.

Meanwhile, the National Minimum Wage applies to people who are at least at the school-leaving age.

9. Keep up with all payroll legislation and compliance

Staying on top of payroll legislation and laws can be challenging because they are continually changing.

Real-Time Information, the Cycle to Work Scheme, and the gender pay gap are examples of how social influences can impact payroll legislation.

You should take advantage of resources such as Gov.uk to understand what changes will mean for payroll as they happen.

Attending payroll seminars, watching webinars and going to industry conferences can help to enhance your knowledge, too.

10. Simplify payroll tasks with technology

Managing the many moving parts of payroll is a lot to juggle.

There are software solutions that use automation, smart data and connectivity to save you time on manually uploading payroll data.

This can help you to generate reports quickly, reduce errors and maintain compliance.

A modern cloud payroll software solution can simplify your payroll operations, so you can focus on strategic ways that the HR function can help the business to grow.

How does the payroll process work?

If you’re doing payroll processing for the first time, you’ll need to register your business as an employer, so you can pay tax and NICs for your employees.

You can do this up to eight weeks before the first pay day rolls around.

HMRC will then send you a Pay As You Earn (PAYE) reference number and an Accounts Office reference number, which are critical for your business to run payroll .

In order for your business to be legally compliant, you’ll also need to choose a payroll processing solution that makes accurate and timely payments.

There are three options:

• Your business can run its own payroll by using HMRC-compatible payroll software
• If you have fewer than 10 employees, you can use HMRC’s free Basic PAYE Tools (or you can use payroll software)
• Alternatively, you can outsource payroll processing to a payroll provider, which can be anything from a qualified accountant to a dedicated payroll bureau.

9 steps of the payroll process

Once you set up payroll, the payroll process consists of nine important steps:

1. Collect employee information

Your business must collect and maintain accurate and up-to-date employee information, including employment contracts, payment details and tax codes.

For example, when a new team member joins a retail shop, the HR manager collects their P45 form to work out the correct tax code and puts their bank details on file in order to pay their salary.

2. Record hours worked

When processing the pay of employees who work for your business on an hourly basis, you must record the number of hours worked, the amount of overtime completed and any absences from work.

A consulting firm, for example, uses a digital timesheet system to record employees’ start and finish times. This ensures that employees receive pay for the correct number of hours.

3. Calculate gross pay

Work out gross pay by multiplying an employee’s pay rate by the number of hours they worked within a certain pay period and include overtime, holiday pay, bonuses and commissions.

For instance, an estate agent might add commission earnings to the basic salaries of its agents and these additions must be reflected in payroll.

4. Calculate payroll taxes

An employee’s tax payments depend on their tax code and National Insurance category letter.

If you’re doing manual payroll calculations, you can use HMRC’s calculators and tax tables to check that you’re on the right track. You can also use them to check tax, NICs and student loan deductions.

If your business is using payroll software, you should be able to access these features as part of the package (but check with the vendor if you’re unsure).

5. Calculate employee deductions

Determine if there are any other payroll deductions that should be taken into account, such as pension contributions.

To make accurate payments, it’s critical to be clear about the difference between pre-tax deductions and post-tax deductions, and ensure you work them out at the right point of the payroll process.

6. Calculate net pay

Once you’ve worked out taxes and employee deductions, subtract them from the gross pay.

The resulting figure is known as the net pay, or employee’s take-home pay, which is the amount your employees will actually receive for the period.

7. Approve payroll

Typically, the payroll manager or the head of HR is responsible for approving the payroll.

But before payroll processing begins, it’s essential for them to do a comprehensive review to ensure that employees will be paid correctly and that your business will comply with all relevant laws.

8. Pay employees

You can choose to pay your employees in the form most convenient for your business—whether that’s via BACS, online payment, cheque or even cash in hand.

Regardless of the payment method, your business must pay its employees by the agreed pay date and issue them with a record of their pay, either electronically or in hard copy.

It’s a legal requirement that the payslip shows employees’ earnings before and after deductions, the amount of deductions and the number of hours worked.

9. Report PAYE and NICs to HMRC in real time

Use Real-Time Information (RTI) to send payroll information to HMRC on or before payday. This consists of employees’ pay, deductions and PAYE and NICs information.

In addition to paying employers’ National Insurance contributions, you should also pay tax and National Insurance deducted from your employees. This is usually by the 22nd day of the following month.

How long does payroll take to process?

Payroll processing times vary depending on the size of your business, how many employees it has, the payment method it uses and whether or not it uses timesheets.

Small businesses should typically expect the payroll process to be completed within one to three days, depending on:

• The accuracy of the data: incorrect data slows down the process.
• The number of employees: the higher this is, the slower the process will be.
• The complexity of the payroll structure: the more complicated it is, the longer the process will take.
• Payroll frequency: weekly or fortnightly pay runs take more time and resources than monthly pay runs.
• Manual versus automated payroll: automated payroll is substantially quicker and more accurate than manual payroll.
• Internal versus outsourced payroll: outsourcing payroll processing tasks to third-party service providers initially takes a little longer than internal payroll, but it eventually speeds up the process and frees up internal resources to perform other tasks.

Payroll process tasks to manage

Beyond the initial payroll process, your business is legally required to keep payroll records for at least three years. This will ensure that it’s ready for an on-the-spot audit, if one is ever carried out.

Your business is also responsible for reporting any changes to employee details to HMRC, such as a change of address.

And following the end of a tax year (5 April), as part of your payroll year end duties, your business will need to:

• Send its final Full Payment Submission (and in some cases your Employer Payment Summary) for the year
• Issue P60s to employees detailing their pay and deductions (by 31 May)
• Report any employee benefits and expenses
• Complete any workplace pensions auto-enrolment duties (if your business has eligible employees).

Final thoughts

Payroll processing is a sizable yet manageable task for your business.

By following the key steps—from recording employee hours to sending RTI to HMRC—your HR manager or payroll manager can rest assured that their processes are efficient and compliant.

And by using payroll software, they simplify the process further by pooling all the critical information into one place, automating repetitive tasks and providing transparency for the purposes of compliance and auditing.

This transforms your payroll into a seamless process, guaranteeing timely payments to your employees with no extra hassle for your HR or accounts departments.

Editor’s note: This article was first published in December 2019 and has been updated for relevance.