How to Make Payroll
Reading Time: 8 minutes In this article, you’ll learn the following: As a small business owner, you might not have a big in-house accounting team to handle payroll. But you have an obligation to your employees to make payroll every pay period (weekly, biweekly, semimonthly, monthly, etc.) – and the IRS expects you to pay payroll taxes. Here are a few things you need to know to efficiently make payroll:
  • Who is working for you?
  • How many hours have your employees worked (if you pay them hourly)?
  • How much in taxes, and what types of taxes do you owe to the IRS?
Your time is best spent on high-value tasks that move the needle for your small business, so you should set up a payroll system to meet those obligations. In addition to a top-notch payroll solution, you need to have enough cash on hand to pay your employees.

How to Set Up a Payroll System

There are five steps involved in setting up a payroll system. Step 1: Get an Employer Identification Number An Employer Identification Number (EIN), also known as a Federal Tax Identification Number, is a number that the IRS uses to identify a business entity. You need an EIN for employees’ withholding taxes and tax forms. You can apply for an EIN through the IRS, but they limit EIN issuance to “one per responsible party per day,” so you should apply as soon as possible. Step 2: Decide on a type of payroll system There isn’t a “right” type of payroll system – it depends on your business needs, how much time you have available, and your skillset. If you are good with numbers and have a bit of free time, for example, you can use payroll software, such as Gusto. What if you want to have very little involvement with the payroll process? In that case, you might want to hire a bookkeeper and/or Certified Public Accountant (CPA) to create and manage a payroll system. You would still be responsible for the accuracy of the information and approvals, but you would have to do much less grunt work. Here are a few benefits of leveraging a payroll provider and staff:
  • They help you stay on top of changes in tax requirements. For example, you currently have to keep records of employment taxes for four years. That’s just one of many tax requirements – it could be extremely time-consuming to stay up-to-date on all of them.
  • You may be able to find payroll software that integrates with your time-tracking software – or has its own time-tracking features. If you have hourly employees, this can make it much easier to calculate payroll.
  • By using payroll software and staff, you are likely to reduce the frequency and severity of payroll mistakes. It may be easy to rectify inaccurate employee paychecks, but the IRS might not be so understanding.
As with any system, the first version doesn’t have to be the final version. You should constantly evaluate the system – particularly in the early going – to find areas for improvement. Step 3: Have your new hires fill out tax and bank forms Your new employees need to fill out a Form W-4 and provide you with their social security number, filing status, and their number of dependents. With this information, you can calculate withholding taxes. If you’re paying your employees via direct deposit, they need to provide their bank information. For employees who opt to receive a check every payday, you’ll need to know where to send the check. Step 4: Decide on a payroll schedule Nearly seventy percent of U.S. private businesses pay their workers biweekly or weekly. Semimonthly (specific days such as the 1st and the 15th) and monthly pay schedules are less common but used by some small business owners. So, how do you decide what payroll schedule is right for your business? Well, to start, you should check with your state’s labor or workforce office to see what pay schedules are compliant with your state’s labor laws. From there, you should consider your employee pay expectations and the particulars of your business. Let’s say the industry standard is a biweekly schedule – in that case, your employees may not be on board with a monthly schedule. What if your business invoices clients after rendering services – and it takes three months to render the service? In this example, you might want to use a monthly schedule, if possible. As you can see, there are a number of variables. Consider hiring a CPA to help weigh your options. Step 5: Set up a bank account for payroll You probably already have a business bank account, so you might be tempted to use that account for payroll, but a better option is to open a separate bank account. By doing this, it will be much easier to maintain payroll records and make sure that you have enough cash on hand to cover employee wages every pay period. For example, you need $20,000 every two weeks to make payroll. If you had just one account, you’d have to determine how much money you need for everything else to know if you have enough for payroll. But with a bank account dedicated to payroll, you just have to think in terms of how many pay periods you can cover with the current balance.

How Do You Run Payroll?

Now that you know how to set up a payroll system, the next step is to run payroll. Here’s how to process payroll:
  1. Calculate your employees’ net pay. To do that, you have to calculate their gross pay, which could be a fixed amount, based on employee hours, factor in overtime pay, or be calculated some other way. You also have to determine their income tax withholdings, including FICA taxes (Medicare taxes and Social Security taxes) and any other applicable income taxes.
  2. Send the employees’ net pay to their bank account or physical address.
  3. Report taxes to the federal, state, and local tax authorities.
  4. Send tax payments to the tax authorities.
As you can imagine, this process is much easier with the help of a payroll service and/or payroll staff.

How to Make Payroll

You can have the best payroll system in the world, but if there’s not enough money in your business bank account to make payroll every pay period, your business is going to be in trouble. So, how do you ensure that there’s always enough money to make payroll? Start by looking at your working capital, which is your current assets minus your current liabilities. Your current assets are anything that can be converted into cash in the next 12 months, and your current liabilities are financial obligations that are due within that same 12-month period. A few examples of current assets are accounts receivable, inventory, and bank accounts. Current liabilities include accounts payable, interest payable, and taxes owed within the next year. The ideal working capital ratio is usually between 1.5 and 2.0, but it varies depending on your type of business and operating cycle. Why not just look at the cash balance in your business bank accounts? You should also pay attention to your cash flow, yes. But your cash position could be deceiving, as you could have a lot of upcoming financial obligations in your current liabilities. Your cash position helps you predict whether you can make payroll in the immediate future (next 2-4 weeks), while your working capital position gives you a better idea of whether you can cover your payroll over the next 6-12 months. What if you currently don’t have enough cash to make payroll, or you think you won’t be able to cover payroll sometime in the future? In either of those cases, you should look into short-term financing options. Here are a few possibilities:

Term Loan

A term loan provides a small business owner with upfront cash to be repaid at predefined intervals at a variable or fixed interest rate. You can get a term loan for between $25K and $500K, with payment plans ranging from 12 to 36 months. The length of a term loan makes it a good option for small business owners who expect to be low on cash for a year or more.

Business Line of Credit

Have enough cash to make payroll now, but not sure if you will in the future? A business line of credit might be the right choice for your small business. With this financing option, you can borrow what you need, when you need the money – and you only pay interest on the amounts borrowed. A business line of credit typically has a variable, not a fixed APR – so you won’t know your interest rate ahead of time.

Business Credit Card

A business credit card is sometimes a good way to make payroll, but only in certain situations. For example, you get a business credit card with a 0% APR introductory period of one year, and you can pay back the borrowed amount within that period. Here’s another situation where a business credit card might be the right choice: you are short for this week’s payroll, but you have a lot of cash coming in next week – before you have to make the credit card payment.

The Bottom Line

With a payroll system, you’ll have a well-oiled machine that pays your employees and the tax authorities – with a small amount of your own time required. But what if you need short-term financing to cover payroll costs? You could go with a traditional bank loan, but the “time to cash” could be as long as a few months – not a viable option for something like payroll. An online small business lending platform like Biz2Credit, however, can get you the cash you need to cover payroll in as little as a few days. You don’t have to take our word for it – consider the case of Paul Gerald, owner of G&G Healthcare. Gerald was at risk of not making payroll for the first time in 15 years due to something outside of his control. He needed money in his bank account in three days or less – and the bank wasn’t moving fast enough. Gerald’s payroll management company, Paychex, referred him to Biz2Credit. With the help of Biz2Credit Loan Specialist, David Tenpa, Gerald had the money in his account within 48 hours. Learn how Biz2Credit can quickly help you get financing for your small business.

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