Maintaining a strong credit profile is critical for early-stage business success. It can impact an owner’s ability to secure future financing, rent commercial space and negotiate better terms with vendors. Paying bills on time certainly helps credit scores, but with growth comes additional cost considerations. Payroll expenses, in particular, must be included in financial projections if the business plans to hire employees.
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What is a payroll expense?
A payroll expense is any direct or indirect cost an employer incurs as a result of compensating people. The sum total of these costs is often the largest figure on a business’s balance sheet. Payroll expenses are especially high in service industries where revenue is tied to hours worked by employees.
How do payroll expenses work?
Payroll expenses accrue throughout a pay period. At the end of that time, employers determine their total payroll cost by calculating the amounts payable to employees, government tax agencies and insurance providers. They must also account for fees associated with payroll and benefits administration.
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Payroll expenses can be direct or indirect and fixed or variable. Specific examples include:
Employee compensation
This payroll expense consists of salaries, hourly wages, bonuses, commission and overtime pay. Some of these costs are fixed, such as salaries, whereas others are variable, e.g., overtime.
Benefits
Benefits can help attract and retain talent, but they also increase payroll expenses. Depending on what they choose to sponsor, employers may have to cover the costs of group health insurance, retirement savings plans, life insurance, paid time off (PTO), etc.
Payroll taxes
Employers are required to pay Federal Insurance Contribution Act (FICA) tax, also known as Medicare and Social Security tax, as well as unemployment tax. These payroll expenses are calculated based on employees’ gross, taxable wages.
Payroll administration
Processing payroll may require purchasing payroll software, hiring a payroll administrator or contracting a payroll service provider. These expenses are considered indirect payroll costs.
Compliance
There are many federal and state employment laws governing payroll. Failure to comply with these regulations can result in fines and penalties, thereby increasing payroll expenses.
Workers’ compensation insurance
Most businesses are required to carry workers’ compensation insurance in case any employees suffer work-related illnesses or injuries. The cost of coverage depends on the employer’s industry, claims history and other factors.
How to manage payroll expenses
Payroll is a cost of doing business for anyone with employees. Yet, while payroll expenses can’t be eliminated entirely, employers can manage wasteful spending. Here’s how:
Minimize mistakes
Miscalculations, incomplete payroll records, late wage or tax payments, and other common payroll mistakes can be costly. To minimize the risk of penalties, employers should consider working with a payroll service provider. ADP, for instance, automates payroll processing so there’s less chance of human error. Compliance support and tax filing services are also available.
Go digital
Mailing paychecks incurs paper supply, printing and postage expenses. Employers can cut these costs by offering electronic payments, like direct deposit or pay cards. As an added bonus, electronic payment methods are more convenient for employees and may improve their engagement. Note, however, that employers must comply with all applicable state rules governing electronic pay and pay statement delivery.
Improve workplace safety
Experience modification is an important factor when calculating workers’ compensation premiums. For example, a business with many prior workers’ compensation claims may have a higher annual premium than a business with fewer claims. Making the work environment safer reduces the risk of workrelated illnesses and injuries, thus minimizing the number of potential claims.
Reduce overtime
Overtime that accounts for less than 5% of the total hours worked is a reasonable response to fluctuating workload volumes and employee absences. When overtime exceeds this mark, it’s usually due to excessive absences and poor scheduling practices. Employers can improve the situation and save money with time and attendance solutions, like those offered by ADP. The software makes it possible to more accurately track employee time and create schedules that result in better shift coverage.
Beyond payroll: Other types of operating expenses
Operating expenses – e.g., costs incurred through the production of goods or services provided – aren’t limited to payroll. Two other primary examples are workplace expenses and sales and marketing expenses.
Workplace expenses
Having a physical work location or job site usually requires paying rent and utilities and purchasing office supplies, tools or equipment. These costs indirectly impact a company’s operations because they enable employees to produce goods or perform services.
Sales and marketing expenses
Once a good or service is ready for sale to the general public, a business will incur sales and marketing costs. These include advertising, website maintenance, social media activity, promotional materials, shipping fees, etc. Increasing awareness amongst shareholders and investors may also require marketing dollars.
Frequently asked questions about payroll and expenses
Is payroll an expense?
For many businesses, payroll is one of the largest expenses they incur. Properly managing it is crucial to their financial health.
What are operating expenses?
Operating expenses are costs incurred by a business while producing a good or providing a service. The three most common examples are payroll or compensation expenses, workplace expenses, and sales and marketing expenses.
Where would payroll expenses appear in financial statements?
Payroll expenses are typically listed on a business’s income statement. If using accrual accounting methods, employers report the expenses for the accounting period in which they were incurred.
What is the difference between salary expenses and payroll expenses?
Salary expenses are a type of payroll expense specific to the base wages paid to employees. Payroll expenses are broader, encompassing not only employee wages, but also payroll taxes, benefits, payroll administration and workers’ compensation.
Is payroll a liability?
Until paid, payroll expenses are recorded as liabilities in accounting ledgers. Two of the most common liabilities in payroll are wages payable to employees and taxes payable to government agencies.
This article is intended to be used as a starting point in analyzing payrolling expenses and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
