Figuring out how to pay employees when starting a business is often tricky, particularly when you have no experience in running a company. There are many things to consider, like your company’s finances, your employees’ preferences, the legal side of things, etc.
If you are not sure where to start, our small business salary guide can help you prepare. Below are five essential steps you need to take to make sure you develop a no-nonsense system and a few additional tips that will help you with the payroll process in your new company.
Without further ado, let’s dive right in.
Step 1: Compensation Type
There are many different ways to pay employees and types of compensation plans, so it is better to cover them first and discuss processing payroll later.
Here’s a list of the most popular compensation types used by small businesses in the USA and a brief explanation about each one of them.
Hourly Wages
An hourly wage is a compensation type in which the employer pays their employees at a previously set hourly rate.
For example, if you hire an employee at an hourly rate of $25 and have them work 40 hours for you, you will need to pay them $1,000.
Hourly wage compensation is the best way to pay employees in small a business who don’t have a consistent schedule or are hired part-time. Moreover, it is ideal for newly founded businesses as it allows the owners to experiment and gauge exactly how many associates they need and how often they need them.
Annual Salaries
An annual salary is a compensation type in which the employees get paid at a previously set yearly rate on multiple paydays throughout the year.
For example, if you arrange to pay an employee an annual salary of $104,000 on a bi-weekly basis, their salary will be $4,000 for each of the 26 pay periods in the year.
Generally, annual salaries are paid to full-time employees with predictable schedules and higher company roles in already established businesses, making them less than ideal for newly founded small businesses.
Commission-Based Salaries
Salaries based on commissions is a compensation plan in which employers pay their employees a previously set hourly or annual salary and additional earnings based on their sales.
For example, you can hire an employee at the $16.65 hourly rate and offer them a 20% commission. If they worked for 80 hours in the given pay period and made 1,000 worth of sales, you will need to pay them $1,332 as hourly wage plus $200 as commissions.
As you can probably tell, paying employees commission-based compensation is ideal for sales roles, as it stimulates employees to achieve better results.
Deciding the Right Compensation Type
Each compensation plan comes with its own pros and cons and is more suitable for specific businesses. What’s important to note here is that you can use multiple ways to pay employees with different roles, schedules, levels of experience, etc.
Don’t be afraid to mix things up and offer different compensation plans to your employees. Everyone has a different preference, and if a salesperson in your company believes they can thrive with commission-based pay, you should do your best to give them an opportunity to do so.
Step 2: Payment Amount
Determining the right amount of money you will be paying your employees is something that most new small business owners struggle with, because there is no simple solution for it.
As a business owner, you want to make money, but your employees want to make money as well. There are different formulas that can give you an idea of how much of your revenue should be allocated to paying employee salaries, but they don’t fit in every situation.
You can come closer to finding the right number by conducting thorough market research and learning how much your competitors are paying their employees. Ideally, offering competitive wages can help you recruit top talent and retain your workforce, but there are also budget limitations you need to consider.
Additionally, you should keep in mind that average salaries vary from one location to the next, so you need to only stay competitive in your local market.
In the end, no one can give you the right answer on how much you need to pay your employees, and you will need to make this decision yourself.
Indirect Compensation
In addition to the main three salary compensation plans we mentioned earlier, there are other incentives you can use to reward the hard work of your employees, including:
- Performance-based bonuses
- Benefits like medical insurance, pension plans, etc.
- Paid holidays, vacation, and sick days
These forms of indirect compensation should play a role in determining how much should you pay your employees.
Step 3: Payment Frequency
While determining the compensation types and how much you will be paying your employees, you should also think about how often you will be paying them.
There are four main payment frequencies in the US, and we will cover all of them and help you decide which one will be a good fit for your business.
Weekly
With the weekly payment frequency, you will pay employees’ salary once every week, which means you will be putting out 52 paychecks per year. While most employees are happy with a weekly payday, it leaves employers with a heavy administrative burden every week. On the other hand, employers appreciate the smaller salary cash flow requirements of weekly pay.
Bi-Weekly
In a bi-weekly payment frequency, employees are getting paid on the same day of the week, every two weeks, which means you will pay your employees 26 paychecks per year. A bi-weekly salary is the most commonly used payment frequency in the US because it balances out the pros and cons of weekly and monthly payments.
Semi-Monthly
At first glance, the semi-monthly payment frequency seems very similar to the bi-weekly, but it actually works very differently. Rather than paying your employees on the same day of the week, you will be paying them on the same date of the month, resulting in 24 paychecks per year and a lot of confusion for both the employees and the employers.
Monthly
Finally, the monthly payment frequency, which requires you to pay your employees once every month, or 12 paychecks per year. It gives the most consistent cash flows and the least administrative work for the employers. However, many employees despise getting paid monthly, and managing large salary cash flow requirements is not ideal for small businesses.
Determining the Right Payment Frequency
What is the best way to pay employees in a small business, weekly, bi-weekly, semi-monthly, or monthly? Beyond the pros and cons, you need to consider some other important points.
- Laws – in some states, employers can’t pay employees less frequently than every 16 days. If you are located in one of these states, you can eliminate the monthly pay option.
- Compensation types – certain compensation plans are easier to manage with certain payment frequencies, which is why most small business pay their employees bi-weekly.
- Industry standards – if most of your competitors are paying their employees at a specific frequency, it can be hard to convince your employees to get paid differently.
Keep in mind that doing payroll for a small business manually is a viable option as long as the number of your employees is low. When you start to expand and hire new people, frequent paydays can become impossible to manage by hand, and investing in payroll processing software will become necessary.
Step 4: Payment Method
Now that we covered how much and how often you will be paying your employees, it is time to discuss employee payment methods, and there are quite a few options to go over.
Let’s have a quick look at the most popular choices among US small business owners, weigh out their pros and cons, and find out which option best fits your business.
Direct Deposit
Direct deposit is the most commonly used employee payment in the US. It is a fully electronic transaction that gets the funds from the company’s account to your employees’ accounts.
After collecting the necessary information from your employees, direct deposit is a very convenient way of putting out salaries. It is quick and easy and works even better with payroll processing software. It can work just as well when processing payments manually, but if you miss running the payroll in the processing time frame, your employees will not get paid on time.
Additionally, some employees struggle with getting pay stubs from direct deposits, so you will need to help them out.
Paper Check
Even though some employers consider them outdated, paying employees with paper checks has its own advantages.
They leave a neat paper trail, they are cheap, and they don’t require employees to share banking information with their employers. On the other hand, they require the most administrative work, they can be forged, lost, or stolen, and they require your employee to be physically present to get paid.
Running paper check payroll for small business owners is a viable option, but for companies with large workforces, the cons can outweigh the pros, especially with so many other options available.
Pay Card
One of the more innovative methods of paying employees is providing them with company pay cards and loading them with their salaries on payday. Like direct deposits, this payment method works with electronic transfers and eliminates the use of paper.
As a matter of fact, paying employees with pay cards has all the benefits of paying them with direct deposit, with the additional advantage of not requiring their bank account information.
However, pay cards are the costliest option as they come with some extra fees, like withdrawal charges, which can be avoided with other payment methods.
Cash
Finally, you can use cash to pay employees’ salary though most employers avoid this option because it attracts unwanted attention. Handing money in hand raises suspicion for the IRS, and cash salaries can make your company more likely to get flagged for an audit.
What’s more, keeping records of cash payments can be tricky and laborious, particularly for companies that have frequent paydays.
The only advantage of paying your employees in cash is that there are no absolutely no processing fees associated with it.
Weighing the Options
Beyond the pros and cons of each method, consider how convenient it will be for you to keep records of the payments, your budget limitations, and your state laws.
In some states, employers are obligated to provide multiple payment method options to their employees, which can work in your favor. Ultimately, the best way to pay employees is to allow them to choose their preferred method by themself, as long as your business can sustain it.
Step 5: Process Payroll
After taking care of every little detail, you should have all the necessary information to create a payroll processing system that you can use for every payday.
A dependable system will allow you to correctly calculate salaries, pay your employees on time, work out the deductibles, and always keep your records up to date.
The process should look something like this:
- Collect the necessary paperwork – Gather the necessary information and documentation from your employees. This includes IRS forms, state forms, USCIS forms, and other necessary paperwork. If you are planning on using direct deposits for paying your employees, collect their bank account information as well.
- Calculate the gross pay – Considering you have already determined employee salaries, compensation plans, indirect compensations, and payment frequencies, calculating gross pay should be easy enough.
- Work out the tax withholdings – Using the information from the first two steps, calculate how much you need to withhold for federal, state, and local taxes. Additionally, if necessary, you can calculate other deductions like healthcare and retirement plans in this step.
- Calculate net pay – The net pay was practically determined in the previous two steps. Go over everything and make sure you’re paying your staff the right amount.
- Pay your employees – All calculations are done, and you are ready for payday. Using their preferred payment methods, distribute the payments to your employees.
- File taxes and benefits – As an employer, you are responsible for filing W2s with the IRS and taxes with the state and local tax collection agencies. If you are paying your employees any additional benefits, you can also take care of them during this step.
- Update the records – Employers are also responsible for keeping their records current for at least three years in case of an audit. Do your best to always keep your books updated with details of employees’ salaries, worked hours, deductibles, etc.
Following the above steps should allow you to manage payroll for small business owners both manually or with the help of a software payroll processing solution.
Additional Tips
Here are a few extra tips concerning doing payroll for a small business we didn’t get a chance to mention in our guide.
How to Pay 1099 Employees
Independent contractors are classified as 1099 employees, and they are responsible for their own taxes and deductibles. When paying independent contractors, ignore the payroll process above and just calculate their gross wages for the pay period and pay them in full. They will take care of the rest by themselves.
Keep Up to Date With Payroll Laws
It is your responsibility as an employer to understand and adhere to employee payment laws like minimum wage, overtime, vacation pay, holidays, etc. Regulations and compliance are evolving matters and subject to change at any time. Be sure to stay in the loop and adjust your system accordingly whenever the law requires you.
Utilize a Payroll Processing Tool
If it’s within your budget, consider investing in payroll processing software. With it, you can automate the larger part of your payroll processing system and ensure your employees are always getting the right amounts and are getting them on time. Moreover, they can help you with bookkeeping and staying compliant with payroll laws.
The Bottom Line
Who knew that so much work is required to pay an employee in a small business? In all honesty, the process seems more intimidating than it actually is. Once you collect the necessary information and develop a payroll processing system, paying employees will become second nature to you.
Just be sure to involve your employees in the initial setup and listen to their input. By balancing between their preferences and your company’s capacity, you can create a dependable payroll processing system that everyone is happy with.