How to Calculate Payroll: A Complete Step-by-Step Guide

MAY 16, 2024

Starting a new business is full of challenges, even for the most experienced entrepreneurs. Because there are so many moving parts, it is common for some elements to be pushed aside if they aren’t immediately pressing.

Some new business owners may be great at identifying and managing talented staff or marketing their services to grow a customer base. But without the commitment to efficiently running the fundamental operations of every business, those skills won’t have a chance to shine. One of those operations is payroll.

Understanding how to calculate payroll is essential. It ensures that your business is compliant with the various employment and tax policies in your area, as well as building confidence in your staff that their work will be compensated with reliability. Unfortunately, payroll is one area of business that entrepreneurs might not place much focus on or in which they might not be well-versed.

But it doesn’t have to be a headache. Here is a quick breakdown of the payroll process and why grasping the details can help your business grow.

How to Calculate Payroll

Much of the payroll process begins with calculating gross wages — whether hourly or salary — and then subtracting deductions and taxes from that amount to determine the final payment that employees receive in their paycheck. Those gross wage calculations and following deductions are dependent on several factors in each case, but here are some general guidelines and examples to keep in mind.

Calculate Hourly Gross Wages

Many businesses pay their staff on an hourly basis. This means keeping an accurate track of hours worked. Timekeeping is an essential part of the process. Not only does it determine how many hours need to be compensated but also if there are any changes in wages such as overtime or hazard pay.

For example, if an employee making $15 per hour works 46 hours in a week, with six of those hours counting as overtime work, the equation would be as follows.

• 40 hours worked at regular rate of $15 per hour: 40 x 15 = $600
• Six hours worked at overtime rate of $22.5 per hour: 6 x 22.5 = $135
• Total Gross Pay for the week: $600 + $135 = $735

Calculate Salary Gross Wages

A somewhat simpler process given its basis in a predetermined number of hours — generally on a 40-hour workweek — salaried wages depend on which pay period schedule you opt to run. Some employers opt for semimonthly pay, meaning twice per month and equaling 24 pay periods, while others opt for a payroll schedule of every two weeks, meaning 26 pay periods.

For this example, if an employee makes an annual salary of $67,000 and is being paid on a semimonthly schedule — assuming a general predetermined 40-hour workweek — the calculation for their gross pay would be as follows. 

• $67,000 annual salary divided by 24 pay periods: $67,000 / 24 = $2,791.67

Account for Voluntary Deductions

Many businesses with full-time employees offer various benefits in addition to monetary compensation. Whether providing healthcare, retirement savings, or other similar options, many of these benefits are offered on a “pre-tax” basis. If there are any benefits the employee has elected to deduct from their paycheck, they need to be subtracted in the step of the process that is legally required, whether that is “pre-tax” or after taxes have been taken out.

Subtract Necessary Taxes

Once any necessary benefits have been deducted from the employee’s paycheck, the most complex part of the process arrives. Understanding and correctly executing payroll taxes are an essential step for every business.

Those running payroll should be well-versed in federal taxes such as FICA (Medicare and Social Security) and unemployment taxes. They should also monitor how any state taxes or local tax might apply to their business and what should be subtracted from their employees’ gross pay.

Pay Your Employees

Even when gross pay has been calculated, benefits have been elected, and those taxes have been withheld, the payroll process is still not yet complete. Employers must be able to execute their payroll to get employees the wages they have earned. This means finding a way to pay your staff in full; and paying them on time.

An efficient system is one that appears seamless to the employees who receive checks in their hands or direct deposits to their bank accounts at the end of each pay period.

How Understanding Payroll Can Help Grow Your Business

Running an efficient payroll operation is more than just paying your employees. It adds value in various other ways. Having a complete understanding of your business’s payroll can help you determine whether hourly or salary wages make more sense. It can assist in your process of deciding whether adding more staff is possible or determining how much certain tasks or roles are costing your business based on the time employees are spending doing their job.

Knowing the payroll system inside and out can also paint a picture of what tax effects might be brought on my staffing decisions and can steer you away from any costly errors.

Save Time and Stress by Outsourcing

Most business owners want to focus on their team and their product. Managing staff and interacting with customers are daily responsibilities. But payroll is an essential function to making those aspects of business possible. That’s why so many owners decide to outsource their payroll, whether through simple software or by a full-service provider of payroll and HR solutions.

Payroll Vault has established itself as an integral partner with small businesses throughout the nation, saving business owners time, money, and stress with their proven systems and support. Contact your local Payroll Vault to start a conversation about your payroll woes today!