What are payroll expenses?

Payroll expenses are the costs incurred for paying employees and independent contractors. Businesses can use a monthly or semi-weekly payroll schedule to distribute earnings to their workers and stay on top of bookkeeping. 

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Payroll expenses are more than the cost of labor. They consist of employee wages, payouts to independent contractors, and other costs associated with payroll. You also have to factor in taxes, software, and other costs. This guide will unveil the components of payroll expenses and how to manage your money more effectively.

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Payroll expenses for employers

Payroll expenses consist of several components. While gross wages are the largest payroll expense, business owners also have to consider a few other costs. Here’s the breakdown:

Salaries and wages

Employers must pay their employees for the services that they perform. Salaries and wages are often the largest component of payroll expenses for employers. 

Withholding taxes 

A percentage of every employee’s pay gets withheld to cover State Income Taxes, Federal Income Taxes, Social Security, and Medicare. Employees must fill out a W-4 form and send it to the IRS to determine their tax rate.

Federal unemployment tax withholdings

A small amount of every employee paycheck goes toward financial assistance programs that help people who are unemployed. States and the federal government have their own programs. The first $7,000 of a worker’s compensation gets taxed at 6% at the federal level. You can receive a tax credit of up to 5.4% for the federal program, depending on the state unemployment tax program. 

Benefits withholding

These funds get earmarked for employee benefits. Businesses only have benefits withholdings for full-time workers, but some companies also offer benefits to part-time staff. These are some of the most common employee benefits:

• Health care coverage (health insurance, dental, vision, etc.)
• Paid leave (PTO and sick days)
• Retirement plans
• Life insurance premiums
• Workers’ compensation
• Child care

Payroll expenses for contractors

Employers also pay independent contractors for their services and must include it in their payroll expenses. However, businesses do not have to withhold any of an independent contractor’s gross income. Independent contractors are responsible for paying their own taxes and do not receive benefits from the business.

Payroll expenses vs. other business expenses

Businesses incur payroll expenses to retain talented workers, stay on top of taxes, and fund workers’ benefits. Most other business expenses are more straightforward. You can use advertising costs to promote your business, but those expenses aren’t multi-layered like payroll expenses. Buying materials or filling up your inventory with products is also more straightforward. 

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In most cases, you don’t have to worry about meeting minimum withholding requirements with non-payroll expenses. You are also free to make other business expenses when you please. You can turn on an advertising campaign and shut it down at any time. However, payroll expenses are always due before the 15th of each month or sooner if you use a semi-weekly payroll schedule.

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How to calculate total payroll costs

Calculating total payroll costs can help you set a budget and allocate cash for upcoming expenses. You can follow these steps to calculate payroll.

Start with gross pay

Business owners should begin their calculation with an employee’s gross pay, excluding withholding taxes. If an employee receives $50/hr and works for 40 hours each week, that worker receives a gross pay of $2,000 per week. You should adjust your calculation based on the payroll’s timeframe. If you have a bi-weekly payroll, the employee in this example receives $4,000 every two weeks instead of $2,000 per week. You can calculate annual payroll costs and break them down into monthly and weekly costs.

Determine the payroll taxes

Employees have to complete W-4 forms to determine how much to withhold for taxes. The rules vary for each location. Employers have to account for state and federal taxes. Payroll taxes do not apply to independent contractors.

Add benefits withholding and other costs

Businesses that offer benefits like health care, insurance and 401(k) plans have to include those perks in their payroll expenses. Employers also have to consider group expenses like team activities and retreats. These costs get absorbed by each employee. Having more employees will reduce the average cost per worker for these initiatives.

Payroll tax journal entries

Posting payroll tax journal entries allows companies to stay on top of their financial records. You can use three types of entries to organize your payroll costs.

• Accrued payroll: Accountants should debit accrued earnings and credit wages payable. These entries should take place during their corresponding pay periods.
• Accrued payroll in cash: Cash payments debit your wages payable account and credit your cash position.
• Income taxes withheld: Companies record liabilities for the amount they withhold in income taxes. Once the business pays taxes, cash decreases with a credit, while tax liabilities decrease with a debit.

Strategies for managing payroll expenses

Keeping your payroll expenses organized will make it easier to pay everyone on time while growing your business. These are some of the strategies you can use to ensure paydays go smoothly:

Automate payroll

Investing in payroll processing software can make it less time-consuming and minimize the risk of human errors. Payroll systems will reduce how much you have to invest in outsourcing to monitor these costs. Automated payroll software can also keep up with changes in tax laws.

Avoid overstaffing

Some employers bring on too many workers for too little work. If you bring on more workers but productivity stays the same, it may be time to make some cuts. Employers should consider how hiring a new worker would increase productivity in the long run. They should also consider if the additional cost is worth the marginal increases in the company’s output.

Monitor overtime pay

Employees generally not on salary get extra pay if they work for more than 40 hours per week. While overtime can’t be avoided, small business owners can look for ways to minimize it. Employees are allowed to take overtime if they work more than 40 hours per week. Companies can ensure more people only work 40 hours per week by hiring more workers to split the workload.

Retain talented employees

It costs more money to replace an employee than it does to retain a top talent. New employees will want the market rate, and you will have to train them. You will also have to post job listings and hire recruiters to find a good worker. 

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Meanwhile, giving an existing employee a raise and having good benefits can keep them on board. You can keep payroll and productivity in a good position by retaining your best workers. 

Borrow capital

Borrowing money to cover payroll expenses isn’t sustainable in the long run. However, accessing a business loan, credit line, or working capital can alleviate cost pressures during slower business cycles and ensure your workers get paid. You can then repay the debt once your business gets into its busier months.

Simplify your payroll expense management with Ramp

Payroll expenses are difficult to manage on your own. You have to calculate the gross pay for each employee, determine how much to withhold from every paycheck, and stay in compliance with state and federal regulations.

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Ramp has you covered if you need help with managing payroll costs. You can also assign unlimited virtual cards, stay on top of your business expenses with Ramp's expense management software, and access working capital. Our corporate cards connect with QuickBooks, NetSuite, Xero, Square Payroll, and other accounting software. You can give Ramp a try to see how it can grow your business.