What is payroll processing?

Common frequently asked payroll questions and answers

Processing payroll means compensating employees for their work. It involves calculating total wage earnings, withholding deductions, filing payroll taxes, and delivering payment. These steps can be accomplished manually, but an automated process is usually more accurate and efficient and may help you comply with various payroll regulations.

How do you manually process payroll?

If you’re a small business with only a few employees and choose to process payroll manually, you will need to keep precise records of hours worked, wages paid, and worker classifications, among other details. You must also ensure your calculations are correct and remember to file all the necessary taxes and paperwork with HMRC on time. As you add more employees, the more challenging payroll becomes, and any mistakes you make can result in costly tax penalties.

Payroll’s impact on cash flow

Even if you’re not paying someone else to do your payroll services, it’s still considered a business expense. This is because your employees’ wages and your share of payroll taxes cut into your profit margin. And if business slows down, you may be faced with the difficult decision of delaying payments or diverting money from other resources.

Since a significant chunk of your cash flow goes toward payroll, it’s essential to manage your payroll schedule effectively.

One way to limit payroll’s impact on your cash flow is to create a cash reserve fund. This is done by keeping a percentage of your revenue in another account. This reserve can be a valuable backup to cover payroll expenses during difficult or unplanned cash flow shortages.

Payroll Regulations

Certain aspects of payroll processing are regulated by HM Revenue and Customs (HMRC). Some of the laws you must comply with include:

National Minimum Wage (NMW) and National Living Wage (NLW)

The NMW and NLW entitles workers to a minimum wage, which varies depending on their age and if they are apprentices or not. You need an accurate means of tracking time and attendance so you can apply the correct wages in accordance with the law.

You’re also required to keep certain records for each worker. Payroll records typically include hours worked each day, total hours worked during the workweek, the basis on which employee wages were paid, regular hourly pay rate, total overtime for the workweek, date of payment and the period covered, and total wages paid each period. These records must be kept for at least three years.

Pay As You Earn (PAYE)

PAYE is HMRC's system for collecting Income Tax and National Insurance Contributions (NICs) from employment. For each pay period, you must deduct the appropriate income tax and National Insurance amounts from your employees' wages. You’re also required to match these employee deductions for National Insurance.

National Insurance Contributions (NICs)

Employers must pay NICs on their employees’ earnings. There are different classes of NICs, but typically employers pay Class 1 NICs. The rates depend on the earnings above the primary threshold.

According to HMRC, an employee’s Class 1 National Insurance is made up of contributions:

• deducted from their pay (employee’s National Insurance)
• paid by their employer (employer’s National Insurance)

The amounts deducted and paid depend on:

• the employee’s National Insurance category letter
• how much of the employee’s earnings falls within each band

Read HMRC’s guide for more information on National Insurance Rates.

Payroll processing across the UK

In addition to national regulations, you must abide by specific devolved laws on things like annual leave (which will affect your payroll) applicable to different parts of the UK, such as Scotland, Wales, and Northern Ireland.

Each region may have its own rules governing worker’s rights and entitlements. So, if you’re conducting business across different UK regions, your payroll compliance becomes that much more difficult.

A good way to stay compliant is to task an executive or someone from your legal department to compile a list of all the labour laws that apply to your organisation. Ask that they track changes to existing laws and document any new laws being proposed. Review these findings on at least a monthly basis so you can adequately adapt your operations and avoid penalties.

Apply for an Employer PAYE Reference

An employer PAYE reference is a unique reference number assigned to your business by HMRC when you register as an employer. It is used to identify your business for tax purposes.

You can apply for an employer PAYE reference free of charge online. Once approved, it will stay associated with your organisation for as long as you stay in business.

You must register before the first payday. It can take up to 30 working days to get your employer PAYE reference number; however, you can’t register more than two months before you start paying people.

To pay an employee before you get your employer PAYE reference number, you should:

1. Run payroll
2. Store your full payment submission.
3. Send a late full payment submission to HMRC.

For more information on how to register for a PAYE, read HMRC’s guide to registering an employer.

Documents Required for Payroll

Before you begin processing payroll, you generally need to gather these documents, some of which may be required by government agencies:

P45

When new employees join, they should provide a P45 from their previous employer. This form details their pay and tax deductions for the current tax year.

New Starter Checklist

If the new employee doesn’t have a P45, they should complete a New Starter Checklist form, which will help determine their correct tax code.

P60

At the end of each tax year, you must provide a P60 to each employee, summarising their total pay and deductions for the year.

P11D

If you provide any benefits in kind, such as a company car, you need to report these to HMRC using a P11D form.

Job application

Although candidates often supply a CV, job applications help you obtain consistent information about potential new hires. Most require a signature verifying the accuracy of the details, which you can use to start preparing a payroll record for anyone you decide to hire.

Bank information

If you plan to offer direct debit payment, you’ll need your new employees to provide you with the name of their bank and an account number and a sort code.

Retirement plan documents

Like health benefits, retirement plans are voluntary payroll deductions and require an employee’s signature before you can withhold contributions to a pension scheme or other retirement account.

How to Classify Workers

In order to comply with payroll tax laws, you need to properly classify your workers as either employees or independent contractors. The general steps to do this are:

1. Assess the nature of the work being done. A worker may be an independent contractor if you have the right to control or direct only the result of the work, not what will be done and how it will be done. If you control both what will be done and how it’s done, the worker is usually an employee. You’ll need to pay close attention to this, as incorrectly classifying a worker will be in breach of IR35, and comes with big penalties for non-compliance.
2. Determine if payroll deductions apply. Withhold Income Tax and National Insurance only on wages paid to employees, not independent contractors. These types of workers pay self-employment tax on their income.
3. File Form P60 with HMRC for employees. Include all forms of compensation paid to employees, including wages and tips, as well as the taxes that were withheld.

Pay particular attention to details when determining a worker’s status. Misclassifying a worker can result in costly penalties. If you need help determining the status of a worker, use the advice of experts or HR software to help the process. HMRC provides a handy guide on understanding off-payroll workers.

What is a typical payroll cycle?

The most common payroll cycle in the UK is monthly. See how it compares to other payroll frequencies:

Payroll Cycle	Paychecks Per Year
Biweekly	26
Weekly	52
Semimonthly	24
Monthly	12

Payroll Schedule Considerations

Payroll schedules are a matter of preference, but minimum standards may apply. Employees, especially those in low-wage jobs, usually prefer to be paid more often, but as your pay frequency goes up, so does your payroll processing costs. You’ll need to carefully weigh the expectations of your workforce and your budget and comply with UK laws.

Create a payroll policy

To ensure that your payroll is accurate, processed timely, and in accordance with all regulations, you’ll need to establish guidelines with both your employees and your payroll department. A typical payroll policy covers:

Workweek definitions

Clearly defined workweeks are necessary to comply with UK overtime rules as well as wage payment requirements. You can choose when your workweek starts and ends, but they typically must constitute seven consecutive 24-hour periods. Bear in mind that your people cannot work more than 48 hours a week on average–normally averaged over 17 weeks. This law is sometimes called the ‘working time directive’ or ‘working time regulations’.

Time and attendance

Accurate payroll begins with precise timekeeping. Your employees should know how to log their hours – time clock, paper timesheets, etc. – the approval process and disciplinary action for submitting false records.

Break periods

If employees work more than 6 hours a day, they have the right to one uninterrupted 20-minute rest break during their working day (this could be a tea or lunch break, for instance). The break doesn’t have to be paid—it depends on their employment contract.

When offering rest periods, clearly define their length and let employees know if the break is paid or unpaid and if they need to clock their time.

Overtime

Explain who is eligible for overtime pay and how the rate is applied. Employees must be paid no less than the National Minimum Wage for all hours worked and at least one-and-a-half times their regular pay rate for each hour worked over their standard working hours.

Pay periods

Document how often you will pay your employees. Monthly, weekly, and fortnightly are the most common. Also, note which specific day of the week will serve as payday.

Mandatory payroll deductions

Make clear all that the deductions from employees’ paychecks (typically Income Tax, National Insurance Contributions, Pension and Student Loan Repayments. Read this ADP guide for more information on how to navigate UK payroll deductions with helpful definitions.

Voluntary payroll deductions

If you offer your employees complimentary health insurance or pension plans, explain the costs and how they can participate. Also, provide breakdowns and information on paying for benefits on a pre-tax vs. after-tax basis.

Wage structure

Be transparent about the different ways employees are compensated at your business, whether it’s hourly pay, salary, bonuses, commission, or stock options. In addition, pay careful attention to laws covering the payment of final wages to those who leave your organisation.

Payroll recordkeeping

HMRC requires payroll records to be kept on file for certain periods of time. You should keep your records for at least 22 months after the end of the tax year the tax return is for. Document the recordkeeping and compliance laws that apply to you, and think about how you will maintain employee confidentiality in line with GDPR.

Designate a payroll manager

Every business needs someone to administer payroll. You can hire an employee specifically for this purpose, but in most cases, the role is filled by an office manager, human resources director, or even the owner. As a result, many payroll administrators have responsibilities beyond simply running payroll. They’re often tasked with providing customer support and answering employee questions, analysing the payroll system, keeping up with regulatory issues, working with auditors, and troubleshooting technical errors.

Those who excel as a payroll manager have a specific skill set. They tend to be detail-oriented, organised, analytical, and technically inclined. Their success, however, requires the collective teamwork of employees, managers, and the human resources department. For example, workers must submit accurate information and managers need to promptly approve timecards in order for payroll to be processed correctly and timely.

Track employee time and attendance

How your payroll administrator manages time and attendance – whether it’s a time clock, a mobile app, or a pencil and paper – is entirely up to you. Keep in mind, however, that doing it manually opens the door to human error. You can help eliminate many of these mistakes, speed up workflows, and make the payroll manager’s job easier by using an automated time and attendance solution that integrates with payroll.

Calculate taxes

As an employer, you’re responsible for calculating and withholding money for UK taxes from every employee’s paycheck. The amount you withhold is determined by the tax codes assigned by HMRC. In addition, employers must pay National Insurance Contributions (NICs) and match what your employees pay.

Withhold additional payroll deductions

Employees can choose to have you withhold money from their paychecks for additional payroll deductions. Besides pension contributions, there are other payroll deductions to consider in your payroll policy:

Payroll Giving: This allows employees to donate to charity directly from their gross pay via PAYE, tax-free, increasing the charity's income from regular giving.

Overpayment of wages: Employees may need to repay wages due to errors, overpayment, or unexpected changes. Repayments can be deducted via payroll but must be reasonable to avoid causing hardship.

Overpayment of benefits: The Department of Work and Pensions (DWP) can recover overpaid benefits directly from an employee’s earnings using the PAYE system through a Direct Earning Attachment (DEA).

Court-ordered repayments: Following a County Court Judgement (CCJ) for debts like unpaid council tax, an organisation can obtain an Attachment of Earnings Order (AEO) to recover money from an employee’s net pay.

Child maintenance: The Child Support Agency (CSA) can mandate that a parent pays a portion of their net wages to the other parent via a Deductions from Earnings Order (DEO).

Payroll saving schemes: Some companies offer loans and advances through ethical credit unions regulated by the Financial Conduct Authority (FCA) and saving schemes to help employees save. These deductions should be included in payroll accordingly.

Pay statement compliance

UK law requires you to provide a pay statement in either print or electronic format at the time wages are paid. Some laws allow employees to opt in or out of electronic statements, and you may have to ensure they are able to easily view or print their pay information through self-service portals.

The goal of these regulations is transparency. The hourly rate, total hours worked, gross pay, net pay, and deductions are required details.

How to issue paychecks

You can purchase cheque stock from the bank that has your payroll account or a stationery supply store. When placing your order, make sure that the cheque stock is designed to prevent fraud, uses ink that can be interpreted by bank cheque readers, and has all of the necessary information. Most will display your business name, the employee’s name and address, the cheque number and date, and the bank’s name and address. Once the cheques are printed, seal them in a double-window envelope so that the destination and return addresses are visible, apply the appropriate postage, and put them in the mail. This process can be simplified by using payroll services, which sometimes includes cheque delivery.

Direct deposit vs. pay cards

Printed paychecks were the tried and tested method of compensation for many years, but thanks to technology, there are more efficient and less expensive ways to pay your employees. Two such methods in use today are direct deposit and pay cards.

Direct deposit electronically transfers money from your payroll bank account to an employee's personal bank account. The transaction is instantaneous, and most banks don’t charge for it. For these reasons, direct deposit has surpassed printed cheques as the preferred method of payment. However, employees must have a valid bank account, and it can sometimes take up to two weeks to set up.

Prepaid debit cards or payroll cards are a more recent payment option that’s growing in use. They’re ideal for workers who don’t have a bank account but still want immediate access to their pay.

Whatever wage payment method you choose to offer your employees, be sure to review all region-specific requirements. Most allow electronic payment, but it is generally not the only option.

How can I improve my payroll process?

Long hours spent on administrative work and responding to letters from HMRC or court orders are tell-tale signs that your payroll process could use some improvements. Here are some tips to streamline your operations:

1. Unify your pay periods
   Paying different types of workers on different schedules (i.e. paying hourly employees weekly and salaried employees monthly) complicates payroll. Find a pay period that complies with regional laws and works best across your entire workforce.
2. Invest in payroll software
   The automated features available in payroll software eliminate repetitive tasks like manual data entry. This reduces errors, saves time, and improves compliance.
3. Integrate your payroll with other processes
   Many types of payroll software can be seamlessly integrated with time clocks and accounting ledgers. When these operations are in sync, you may have more accurate payroll calculations.
4. Use digital timekeeping solutions
   Paper timesheets often lead to mistakes. Time tracking software uses biometric identification to prevent fraud and automatically calculates the hours worked.
5. Keep current with regulatory requirements
   Laws governing payroll and employment are constantly changing. Staying informed of the latest legislation will help you maintain compliance and avoid expensive penalties.
6. Work with a payroll service provider
   Often, the surest way to improve your payroll process is to work with a provider who can handle all aspects of payroll on your behalf. You may have peace of mind knowing that your employees are paid on time and your taxes are prepared correctly.

Payroll processing FAQs

See what other employers are asking about payroll processing:

How long does payroll take to process?

The method you choose to process payroll will determine how long it takes. Manual calculations can take hours to days, depending on how many employees you have and the laws that you must comply with. A more efficient approach is to use payroll software, which can run payroll in minutes thanks to automation.

What is full-cycle payroll processing?

The amount of time in between each payday is known as a payroll cycle. It can be as short as a week or as long as a month. During this period, several repeatable steps take place:

• Employees work and track their hours
• Gross pay is calculated based on hourly wage
• Taxes, National Insurance Contributions and other deductions are withheld from wages
• Net pay is delivered to employees via cheque, direct deposit, or pay card

What is end-to-end payroll processing?

End-to-end payroll processing integrates payroll with other aspects of workforce management, such as performance measurement, training, scheduling, benefits, and compensation. By making this connection, you can improve communication, recordkeeping, analytics, and efficiency throughout the employee life cycle.

Why is the payroll process important?

Payroll processing is important because paying employees late or filing taxes incorrectly may result in penalties. Payroll that’s unreliable can also hurt employee morale and tarnish your business reputation. When you consider these ramifications, it’s often best to dedicate the necessary resources, whether it’s time or money, to make sure you get payroll right.

What is the payroll process?

To run payroll for the first time, employers generally must perform the following:

• Apply for a PAYE reference number from HMRC
• Gather employee tax documents (P45 and Starter Checklist)
• Open a business bank account specifically for paying employees and taxes
• Hire or designate a payroll manager
• Develop a payroll schedule
• Create a company payroll policy

What are the types of payroll processing?

When it comes to processing payroll, you have several options to choose from, depending on the size of your business and individual needs. The most common are:

• Do it yourself (DIY)
• Outsource payroll to an accountant
• Purchase payroll software
• Work with a managed payroll provider