How to calculate payroll?

Calculating payroll for a small business involves numerous calculations. But how exactly do you go about this process?

First published on Thursday, May 30, 2024

Last updated on Thursday, Jun 20, 2024

When calculating payroll for a small business, the stakes are high, and the math must be pinpoint accurate. But how do you calculate payroll for a small business effectively?

Well, you’ll need to understand employee gross pay assembly, factor in deductions, and navigate payroll taxes, all while ensuring compliance with HMRC regulations.

In this guide we’ll deconstruct the process into manageable parts without overwhelming you with unnecessary details, equipping you with the knowledge to calculate your payroll right.

Understanding the payroll process

Have you ever wondered what goes on behind the scenes every time a paycheque is issued? The payroll process is a meticulous dance of numbers and regulations. It’s an intricate puzzle where every piece—from employee compensation to benefits and taxes –must fit into place.

Think of calculating payroll as crafting a bespoke suit; it requires precision, tailored to each employee’s unique circumstances.

Manual payroll calculations demand a fine-tooth-comb approach, considering everything from bonuses to benefit deductions and tax withholdings.

Calculating payroll involves walking a tightrope; one misstep in payroll processing could lead to legal hot water or, worse, breach the trust you’ve worked so hard to build with your team.

To calculate payroll accurately upholds the integrity of your business and the wellbeing of your employees— it’s much more than just crunching numbers.

For more information on the payroll process, read our article "What is payroll?".

Three people sitting at a table with paperwork, calculating payroll

Setting Up Your Payroll Schedule

Before you can begin calculating payroll you need to determine your payroll schedule. A consistent payroll schedule sets clear expectations and keeps the cogs of your business machine well-oiled.

According to CIPP's latest Payslip Statistics Report almost 97% of UK businesses run their payroll on a monthly basis.

However, whether it’s weekly, fortnightly, or monthly payments, your payroll schedule should align with your business operations and your employees' job roles.

The frequency of your payroll calculations will link with the pay schedule you set, so choose wisely—this decision lays the groundwork for smooth payroll processes in the future.

Recording Employee Work Hours

The next step, and an important one, is keeping an accurate record of your employees' working hours.

The cornerstone of a fair payroll is capturing the precise number of hours in employee work schedules.  Accurate timekeeping ensures compliant net pay calculations, that abide by the complexities of payroll laws.

Manual time tracking can be as simple as jotting notes in a ledger or as complex as crafting spreadsheets. But why not embrace the digital age?

Automated time-tracking solutions, like Blip our clocking-in app, can manage this task with precision and ease. The outcome is a balanced sheet that accurately represents the work done, providing a solid foundation for confident gross wage calculations.

How to calculate gross wages

Now, let’s explore the peak of payroll calculation: gross wages. This is the grand total of an employee’s earnings before any deductions are taken.

It includes:

  • Regular wages

  • Overtime pay

  • Bonuses and commissions

When calculating gross wages, each element must be carefully considered to achieve accuracy.

How to calculate hourly employees' gross pay

For your hourly employees, gross pay calculation is straightforward: their hourly rate multiplied by the hours worked.

But should they work beyond their scheduled hours, overtime pay comes in.

It’s simple really, their gross pay should reflect the exact hours they worked including any additional work.

How to calculate salaried employees' gross pay

In contrast, we have salaried employees, who have consistent pay. Their gross pay is the sum of their annual salary divided by the number of pay periods in a year.

If your payroll has a monthly pay period, simply divide their annual salary by 12 to find their gross pay.

These employees don’t face the fluctuations of hourly staff. Instead, they can count on a steady monthly income, regardless of the slight variations in their weekly hours.

This predictability supports the rest of the payroll process.

A man in a suit focused on his laptop and paperwork, calculating payroll

Navigating through deductions and allowances

Once, you’ve calculated your employees' gross pay, you’ll now have to work out deductions and allowances.

Navigating through deductions and allowances demands precision. It’s a delicate balance, with income taxes and National Insurance taking centre stage, followed by pension contributions, voluntary deductions, and other non-tax contributions.

All of this is influenced by each employee’s unique tax code and Personal Allowance, which guides the amount of taxes to withhold from their wages.

Understanding how to calculate payroll taxes

Payroll taxes are a significant expense for businesses of all sizes in the UK—not just the small ones. These taxes are calculated based on various factors, including employee earnings, deductions, and exemptions.

There are several payroll taxes that you need to be aware of and comply with, these include:

National Insurance Contributions (NICs)

NICs are taxes paid by employees and employers alike. This tax is used by the government for certain social security benefits.

They are divided into two categories: Class 1 NICs, which are paid by the employee, and Class 2 and 4 NICs, which are paid by the employer.

Income Tax

Income tax is deducted from employee earnings and is calculated based on your employee's personal income tax rate.

There are different tax bands in the UK, ranging from 0% to 45% and the rate of tax applied will depend on the employee's earnings and tax allowances.

Pension Contributions

You are required to make contributions to your employees' pension funds based on the employee's earnings and pension contribution rates.

These contributions are deducted from the employee's salary before tax is calculated.

Student Loan Repayments

Sometimes you are required to deduct student loan repayments from your employee's salary.

This depends on the employee's individual circumstances and the terms of the loan.

Calculation methods for payroll tax

Payroll tax calculations in the UK involve several steps to determine the amount payable. These steps may vary depending on the type of tax being calculated.

However, following these six steps is common:

Step 1 - Deduct allowances

Start by, deducting allowable expenses, such as travel expenses or pension scheme contributions, from your earnings before calculating payroll taxes.

Step 2 - Calculate taxable earnings

After deductions, calculate your employee’s taxable earnings, which are subject to tax and other payroll taxes.

Step 3 - Determine NICs

Determine your employee’s National Insurance Contributions (NICs) based on the relevant NIC rate, their earnings, and any applicable exemptions.

Step 4 - Calculating tax

Apply your employee's personal income tax rate to the taxable earnings to determine the tax amount payable.

Step 5 - Deduct pension contributions and student loan repayments

If applicable, deduct pension contributions and student loan repayments from your employee's salary before calculating payroll taxes.

Step 6 - Summarise payroll tax payments

Finally, calculate the total amount payable for each type of tax and remit it to HMRC.

Man with glasses holding a payslip

Finalising net pay

Arriving at the net pay is the final step of the payroll calculation. This is the amount your employees actually take home after all deductions have been made.

To summarise how we got here, start with calculating gross pay, then make each deduction—taxes and contributions—until only the net pay remains.

This final number shows how their hard work paid off and how carefully you managed their pay and benefits.

How BrightHR can help you with payroll calculations

As our journey through the complex world of payroll concludes, it’s clear that calculating payroll for a small business requires careful attention to detail, a good understanding of regulations, and a dedication to accuracy.

This is not just true for small businesses but all businesses in the UK.

From setting up the right payroll schedule to selecting the appropriate software, each step is instrumental in achieving a harmonious balance between compliance and employee satisfaction.

However, without the right tools, navigating payroll calculations can be challenging. That’s where payroll software comes in.

BrightHR Payroll Software can simplify complex calculations, ensure compliance, and adapt to your business’s unique payroll needs.

With the right payroll solution, you can automate calculations and stay informed about the most recent laws and regulations. Plus, utilising our managed payroll services can enhance efficiency and accuracy in your operations.

Learn more about BrightHR Payroll by registering your interest here!

Janine Lennon

Head of Payroll Services

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