Last reviewed 12 December 2018

Paul Tew, small business consultant and freelance advisor, looks at the issues involved when selecting a system to pay employees.

Due to the complexities and intricacies that payroll presents, many small employers do not wish to process their own payrolls. However, whether operating a payroll system in-house or outsourcing the payroll operation, the employer ultimately remains responsible for ensuring that pay and deduction data is reported correctly to HM Revenue & Customs (HMRC) electronically on or before each employee’s payday.

All employees have a personal interest in payroll, so timely and accurate operation is essential. The advent of real-time information reporting means the electronic payroll systems have largely replaced manual payrolls. Prior to deciding how to set up a small business payroll system, it is imperative to have a clear idea of what functions the system is required to perform.

Understanding the business needs

No two small businesses are the same and therefore each employer must determine which system features match the unique nature of their business. The level of functionality within a pay system varies considerably, with the need to consider industry-specific issues, eg shift patterns, the level of adjustments required each pay cycle and the complexity of the calculations. Take into account where the current payroll system is deficient, what operational problems or additional work is created, and where improvements can be made.

Small businesses may wish to consider integration with other systems such as accounting software. Integrating other systems into the payroll process can help reduce or eliminate certain errors that are commonplace when information is passed between various departments. Any payroll data provided should therefore be compatible with accounting software.

Prior to selecting a payroll solution, employers should consult with the individuals who will actually be using the service or product on a regular basis, as they will be best placed to advise on some of the strategic issues facing the employer. Also, these individuals may have a greater “buy in” to the decision-making process, if involved from the outset. Nevertheless, personal preference must not become an overriding factor to the detriment of other considerations. It is a part of the decision-making process and other objective factors may have an equal or even greater relevance to the overall business strategy.

The payroll system or service should not be overly complex to understand, while remaining affordable, reliable and offering support when the employer and its employees need it. Check the levels of support offered, in particular, the cost and response times.

There is no substitute for defining precisely the requirements that a new system or service must meet and carefully assessing suitability against the set business criteria, as agreed with all relevant stakeholders. When an employer knows what it requires from a payroll system or provider, then it can decide which process to use. At this point a short list of potential solutions can be identified.

Exploring the outsourcing option

When selecting a payroll solution, cost is a big factor to consider for most small businesses. Outsourcing can be costly, but also time effective. If a small employer wishes to spend more time concentrating on its core business activities, then one option would be to pay a payroll processing service to operate pay as you earn (PAYE) on its behalf (such as an accountant or payroll outsourcer) and manage all of the necessary calculations, reporting and record-keeping procedures. Employers should inform HMRC about payroll outsourcing by providing details on the online form available at GOV.UK website. This will help HMRC check if the company submits returns and pays tax and NICs for the employer’s employees.

In taking this course of action, employers must be clear on what services, tasks or functions the payroll outsourcer will be responsible for and those that will remain with the client employer. Flexibility is key, as the employer should be able to dictate the degree of involvement that it will require to the payroll provider. Remember that the employer will still have to provide certain key payroll details, such as form P45s and starter checklists.

Increases and modifications after the effective date of any service level agreement made will normally be subject to a change order procedure, with resultant escalating costs. Employers should find a provider with a transparent pricing structure with no hidden fees, so there is a known cost, which meets the budget constraints for payroll processing.

Managing the payroll internally

An in-house payroll gives greater control but brings with it inherent risks. If deciding to run the payroll in-house, the employer will need payroll software to report to HMRC. There are a wide variety of commercial payroll software packages for small employers to choose from. The choices range from free HMRC payroll software (if the business has fewer than 10 employees) to paid-for software that has been tested and recognised by HMRC.

With HMRC’s basic PAYE tools product, the only cost to the employer is its time. The problem with this situation is that if the employer grows and takes on more employees, then it will be necessary to switch to a different method of payroll provision. Switching payroll systems at a later date will be time consuming, so it is good practice to future proof any solution considering potential technological advances and long-term plans the business has to grow and develop.

HMRC maintains a list of commercial products which have satisfied a range of general tests to report payroll information in real time — see GOV.UK website. Recognised electronic payroll systems can provide a practical solution because the software package deals with all the information required by HMRC for the employer and can also highlight anomalies in processing payroll-related values. However, HMRC cannot recommend one software product or service over another and is not responsible for any software problems encountered by the employer. There are risks in using electronic systems through data losses caused by crashes and viruses.

Choosing the cheapest software product available may not necessarily be the best option. The cheaper the payroll solution, the more manual input the system may require, meaning more human resources are needed to achieve the desired results. How much time will be spent writing up timesheets, processing data or writing reports — remembering the old adage used in business that “time is money”. When considering costs, as well as the purchase costs, factor in the costs in operating, supporting and updating the software.

There is also a hidden cost in compliance errors and potentially HMRC penalties resulting from inaccuracies and late filing errors. Overpayments can also prove costly and time consuming to deal with and rectify, as well as damaging relations between an employee and employer.

Three steps to take when making the final decision

  1. Do all relevant research prior to making any commitment, including networking with other small employers, visiting payroll exhibitions and searching the internet for recent product or service reviews.

  2. Having reached a conclusion on the preferred choice of payroll solution, a detailed business case must be submitted for final approval to the individual or committee responsible for authorising the expenditure.

  3. Any decision about a new payroll system or service should not be purely based on finance, as it is also about adding value to the business by supporting the pay and benefits policy.