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. 

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 each of your employees each pay period (this may depend on how many hours an employee worked), as well as 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 those 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.

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-resourced or under-resourced.

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.

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 role or employee. 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, 1099 contractors, and hourly temp workers. Anyone who works for your company and gets paid in a specific pay cycle – even if it’s not in every pay cycle – 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, healthcare benefits and retirement plan matching contributions. [Learn how to calculate bonus taxes.]

3. Review your payroll budget.

After building your company’s payroll budget by compiling the number and type of employees and cost per employee, 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, as 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 since processing payroll accurately involves staying current on employee tax rates and other items that can vary over time. 

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 understand the most up-to-date payroll budgeting practices.
• 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.
• 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.
• 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.
• 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.

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 so that you can spend your time identifying insights and using them to run your business effectively.