How to Create a Payroll Budget

What does a payroll budget include?

A company’s payroll budget includes all costs directly related to individual employees, including wages, commissions and taxes. It also includes the employer’s employee benefits package costs. When considering different approaches to managing payroll expenses, the size of the company can significantly influence its focus.

“For smaller companies like mine we often focus more on wages, taxes and simpler benefit packages, while larger businesses typically deal with more complex benefits packages and incentive programs,” said Brian Kroeker, president of Little Rock Printing, an e-commerce-based printing solution.

Muhammad Firdaus Syazwani, founder of Dollar Bureau, a personal finance resource, also said small businesses have simpler budgets compared to large corporations. However, he said they must have stringent cash flow management to maintain budget integrity.

Before creating a payroll budget, you must know each employee’s employment type, i.e., W-2 or 1099. You also need to know how much you pay your employees each pay period, which may depend on how many hours an employee worked. In addition, you need to know their respective tax withholdings and benefit elections. [Related article: How Many Pay Periods Are in a Year?]

Here are some standard items included in payroll accounting:

• Wages: How much you pay employees is the basis for all other items included in a payroll budget.
• Commissions and bonuses: Any extra payments employers pay employees, except for reimbursements or tips paid directly by customers, are included in a payroll budget.
• Payroll taxes: While employee income taxes are composed mainly of withholdings from employees’ paychecks, the employer’s share of payroll taxes (FICA) is still included in an overall budget.
• Health insurance benefit premiums: If an employee elects to receive employer-sponsored health insurance and the company pays for all or part of the benefits, that cost is a payroll budget item.
• Company contributions to employee retirement accounts: Any employer-matching, profit-sharing, or other contributions into employee savings or employee retirement plans are part of a payroll budget.

4 steps to create a payroll budget

Creating a payroll budget involves identifying every role or employee within a company and itemizing every individual cost for each. This process is quick and easy for companies that use one of the best payroll services or software.

However, if you want to generate a payroll budget manually, follow these steps:

1. Break down your headcount.

The first part of generating a payroll budget is identifying all the people who work for your company. This can include permanent full- and part-time employees, hourly temp workers, and 1099 contractors. Anyone who works for your company and gets paid in a specific pay cycle — even if it’s not in every pay period — should be included in your budget.

2. Map costs for each person.

Once you’ve listed all of your employees, calculate the total cost for each person on your payroll. Depending on your company’s size and structure, you may be able to do this by position, or you may need to itemize costs by employee. Mapping costs include wages, bonuses, taxes, health-care benefits and retirement plan matching contributions. [Learn how bonuses are taxed.]

3. Review your payroll budget.

After building your company’s payroll budget, it’s essential to review the resulting report. In addition to looking at costs by employee, examine costs by department and in aggregate.

Your payroll budget report should be monitored and tracked over time; it can change from one pay period to the next. Monitoring payroll budget changes allows employers to track the total cost of their payroll, identify key cost centers and find potential savings.

4. Process payroll.

After reviewing your payroll budget and confirming that everything is correct, you’ll process your company’s payroll. In other words: You’ll pay everybody. Processing payroll involves paying the following:

• Wages
• Payroll taxes
• Employee benefit premiums (full or partial)
• Retirement plan matching contributions
• Any other expenses

If you have full-time W-2 employees for whom you must withhold taxes, even the straightforward step of processing payroll can be tedious and time-consuming. It’s considerably easier to work with a payroll service or use dedicated software. With professional help, figures are often far more reliable; this is because processing payroll accurately involves staying current on employee tax rates and other items that can vary over time.

Why is a payroll budget important?

A payroll budget is essential for business owners because it helps them understand the total cost of their employees and the specific items that make up those costs. This understanding helps you gauge whether specific business segments are over- or under-resourced.

“Payroll processing services play a crucial role by handling the complexities of payroll calculations, tax withholdings and regulatory compliance, which can be particularly beneficial for small to medium-sized businesses without dedicated payroll departments,” said Shaun Bettman, principal and mortgage broker at Eden Emerald Mortgages.

Payroll budgets are also crucial because they can help you identify potential savings. Even if it doesn’t involve cutting headcount, changing payroll logistics, such as payroll frequency, can have an effect on total costs.

Tips for controlling payroll costs

With payroll being such a time-consuming task, it’s often a significant loss leader for employees whose time is the most valuable for a business: owners and managers. Plus, there’s the actual cost of payroll — the human expense of running a business. While those costs are a part of running a business, there are things that you can do to keep them in line.

Here are a few tips for keeping payroll costs under control:

Use a payroll service

If you want to generate payroll budgets and reports quickly and reliably, consider using a payroll service. These services stay current on tax and benefit rates, and they understand the most up-to-date payroll budgeting practices.

“These services often offer additional features like employee self-service portals, reporting tools, and analytics that help improve efficiency and transparency in payroll management,” said Bettman.

Track every dollar closely

Payroll can be one of the highest costs in running a business, and there are many different payroll aspects to monitor. It’s essential to track your personnel costs closely over time and know where every payroll dollar is going.

“We hold monthly [if not bi-weekly] finance meetings where we track payroll expenses, such as rising overtime costs or possible inefficiencies in staffing,” said Kroeker. “Analyzing this data on the regular as a leadership group has helped us reveal cost-saving opportunities, helping us maintain financial health.”

Know your cost centers

When you build your payroll budget, you should be able to review each employee’s costs. Understand which team members’ costs are highest in case you find yourself needing to cut costs.

“A common mistake is underestimating the cost of employee benefits or failing to account for potential overtime,” said Kroeker. “We experienced this issue earlier on in our company’s life and found that the best way for us to avoid it is by reviewing past payroll data and making adjustments for any expected changes.”

Balance costs and benefits

Every business has some employees who bring more value to a company than others. Once you know the relative costs of each of your people, be sure you know how much value each person brings to the business relative to their cost.

“Businesses should adopt a comprehensive approach that includes all aspects of employee compensation and any expected changes, such as raises, promotions or increased health-care premiums,” Bettman said.

Be proactive

As with anything else in business, when managing payroll, it’s critical that business owners place themselves in a position to anticipate events, reward valuable employees and shed dead weight rather than react to situations as they occur.

“Payroll analysis also helps businesses stay proactive in managing labor costs by identifying potential areas for cost savings, such as renegotiating benefits packages or investing in training to reduce turnover rates,” Bettman said.

Bettman also said how companies should take into account seasonal fluctuations or unpredictable events like employee turnover. To help predict this, he said companies should review previous payroll data to identify trends and set aside contingency funds.

If you handle your business payroll yourself, it can be challenging to track the numbers closely, especially if you have many employees. The right payroll service or software can help you track your payroll budget easily; this way, you can spend your time identifying insights and using them to run your business effectively.

Mastering your payroll budget

Creating and maintaining an accurate payroll budget is crucial for keeping your business’s finances in check. It not only helps you understand the total cost of your workforce but also empowers you to make informed decisions about resource allocation. Whether you do it manually or have payroll software help, consistently reviewing and adjusting your payroll budget will contribute to your company’s long-term health.

Amanda Clark contributed to this article.