Tips to Manage Payroll Costs for Small Businesses

What is Included in Payroll?

Several entrepreneurs and small business owners make the mistake of considering monthly salaries as payroll. However, total payroll costs are bigger than just salaries and inclusive of many other things like bonuses and income tax. These include:

1. Base Pay: These are the core compensation of your employees mentioned in the salary annexure. These include fixed costs like hourly pay, fixed salaries, or unit-based pay (for manufacturing industries) depending on whether your workers are full-time employees or independent contractors.

2. Bonuses, Commissions, and Ex Gratia Pay: These are the workers' compensation over the base pay and can vary, depending on the employee For example, some small businesses offer performance-based or KPI-related bonuses, while others include commissions based on sales or revenue generated. Other bonuses include ex-gratia payment made as a gift to employees or overtime pay. These variables change monthly in your payroll costs and require close attention.

3. Payroll Taxes: In the US, employers are required to pay approx. 65% FICA taxes on the gross wages of employees. These taxes cover benefits like Social Security and Medicare. In case an employee is laid off, business owners are also required to pay federal unemployment tax (FUTA) and state unemployment tax (SUTA). All these taxes act as an add-on on your existing payroll costs.

4. Paid Time Off (PTO): Business owners offer paid time offs to employees. These can include the leaves mandated under Family and Medical Leave Act for eligible employees and other time offs.

5. Accruals: Business owners need to accrue some amount in their financial sheets to encash paid time offs when an employee resigns, or the owner terminates their contract.

6. Employee Benefits Contribution: Payroll expenses include hidden benefits and contributions towards the welfare of employees. These may include health insurance, 401k retirement plan, and even life/disability insurance.

7. Workers' or Employee Compensation Insurance: Except Texas, the Workers' Compensation insurance is mandated in every other US state. It includes medical benefits and emergency wages for employees in case of an injury. Premiums in Workers' compensation are decided according to the risk level of your job and add up to your payroll costs.

8. Payroll Administration Costs: Along with the costs to run payroll for each employee, the overall payroll costs are inclusive of administration charges as well. These include any software subscription costs, agency costs or HR costs, and payroll service costs for direct deposit, tax filing and year-end W-2/1099 processing.

Ways to Manage Payroll Costs for a Startup or Small Business

Managing payroll is an important aspect of every business. To stay afloat, save preserve margins and avoid non-compliance, small business owners can opt for the following methods.

1. Use a Payroll Software

There are several cost-effective payroll management solutions in the market. These payroll solutions come with essential features to streamline payroll like automated processing, employee-self-service (ESS), direct deposits, unemployment insurance, custom payroll frequency, IRS tax form compliance, and more. Being available on a SaaS (Software as a Service) model, these solutions don't require small businesses to invest separately in hosting servers and save costs.

Pros of Using a Payroll Software

• Automate payroll processing
• Employers can do online payroll from anywhere
• Initially cost-effective

Cons of Using a Payroll Software

• Onboarding can be difficult depending on the selected solution
• Not so cost-effective in the long run because of never ending payments

2. In-House Payroll

Another option to manage payroll costs is by building an in-house team. In the majority of small businesses, the HRs or the owners themselves do payroll. This is most cost-effective as owners aren't required to pay any additional costs. However, in this option, the chances of error are high unless the HR or team is highly trained.

Pros of Doing In-house Payroll

• The most cost-effective method for both short term and long term

Cons of Doing In-house Payroll

• Requires training
• HRs can still make mistakes when processing payroll costs and disbursing payments
• Can be time consuming

3. Outsource Payroll to an Agency

There exist multiple agencies including payroll service providers and Professional Employer Organizations (PEOs) in the industry to take over your payroll work. From calculating payroll costs to monthly processing, these agencies take care of everything. They are also able to ensure high accuracy in the payroll process, and the risk of non-compliance also transfers from the business owner to agencies when you process payroll functions through them.

Pros of Outsourcing Payroll Work

• Higher accuracy in processing because of trained professionals
• The agency becomes responsible for managing compliance with payroll and tax laws
• Most suitable for businesses with good funding

Cons of Outsourcing Payroll Work

• Highly costly

Loans and Financing Options to Manage Payroll Costs

Entrepreneurial journeys are unpredictable. There may come a time when you have to face economic uncertainties because of inadvertent reasons. During such times, small businesses can opt for loans and other financing options.

1. Term Loans

When monthly returns are poor and the pay period is getting close, small business owners can opt for term loans. These fixed duration loans with flexible tenure. The business owner can decide their loan tenure and loan amount. However, the credit approval for these loans may be strict, and business owners may need to show a credit score of over 630 to secure a term loan.

2. SBA Loans

The U.S Small Business Administration offers federal loan programs at competitive pricing. While they themselves don't offer the loan, they help qualifying business owners connect with non-profit intermediaries called Community Development Financial Institutions (CDFIs). The SBA also guarantees the loan, making them highly secure for lenders.

There are two types of loans that owners can take to manage payroll costs:

• SBA 504 Loans: These are microloan with the max loan amount of up to $50,000. These are mostly unsecured loans and have a faster credit approval process.

• SBA 7(a) Loans: These loans have a max loan amount of up to $5 million. However, the credit approval for SBA 7(a) loans is stricter and time consuming.

Business owners can opt for any of these loan options depending on their business needs.

3. Business Line of Credit

For qualifying businesses, certain lenders issue a credit line. The amount of this credit line depends on various factors, like income stability and annual revenue. Business owners can withdraw any amount from this credit line and only need to pay tax on that amount. They can pay back in small monthly payments and free up the credit line. For another loan, owners are not required to re-apply for a loan. This makes a business line of credit a highly flexible option to cover payroll costs.

4. Business Credit Card

Another option like the business line of credit is a credit card. Business credit cards are linked to the business checking account. Business owners can again use these flexibly and secure funds for payroll with minimal processing fees. Depending on their monthly returns, owners can also choose to pay full or part amounts against their business credit card loan.

5. Revenue Based Financing (RBF)

This is a financing option in which instead of making fixed monthly payments, businesses payback in proportion to their monthly revenue based on a pre-decided remit rate. RBF comes with an easy repayment option, is not taxing on the business, and helps keep the debt-to-income ratio in check. It is important to note that RBF uses a factor rate, not an interest rate.

6. Invoice Financing

Many times, businesses strike deals without receiving payment. This leads to cash flow and payroll problems. Business owners can take loans against their overdue invoices at a minimal interest rate and arrange for payroll costs. Invoice financing includes short-term loans, which simplifies repayment.

Final Thoughts

With increasing complexities in taxation and employment laws, even small business owners cannot afford to make any payroll processing mistakes. From calculating payroll costs to tax withholding and timely disbursement, small businesses are required to manage everything. This can be done by investing in a SaaS-based payroll management software, hiring an in-house team, or simply outsourcing the payroll work to a third-party agency. To secure funds to arrange for payroll costs, business owners can opt for multiple loan and financing options including line of credit, SBA loans, invoice financing and revenue-based financing.